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APAC FX Depreciation Expectations Rise

The latest sentiment data from APAC painted a mixed picture. August manufacturing PMIs for China and South Korea fell into the contraction zone for the second consecutive month, while Taiwan's collapsed to 42.7, the lowest reading since May 2020. At the other end of the spectrum, India and Singapore manufacturing PMIs came in much higher, at 56.2 and 56.0, respectively. Overall, aside from upward trending confidence in Thailand (last at 53.7), the downward trend for the rest of Asia suggests faltering growth momentum. China's non-manufacturing PMI eased to 52.6, but the subcomponents offered little comfort: all but one, the business activities expectation, are in the contraction zone.

Renewed COVID-related mobility restrictions across cities in China will undoubtedly weigh further on already-downbeat consumer confidence, as well as on retail and investment activity. It has been reported that more than 70 cities, including Shenzhen and Chengdu, have been put under full or partial lockdowns since late August, impacting more than 300 million people. China's latest (July) consumer confidence hit an historical low of 87.9. Retail sales have been negative since April 2022, with the July reading at -0.2% year-to-date y/y.

Stimulus measures, including a series of targeted credit easing, direct pledges, and measures related to housing, e.g., special loans to help finish projects, relaxation of purchase rules, and lower mortgage reference rates (5y Loan Prime Rate reduced 15bp to 4.30%), have had only a limited impact so far. For example, the average of home prices across 70 cities fell again in July (-0.11% m/m), marking the eleventh consecutive monthly decline. The phenomena of too much money and too little demand continues.

The latest economic stress point in China is the yuan. CNY has weakened sharply in August, by 2.2%. Excluding the COVID lockdown triggered 4.2% depreciation in April this year, it is the biggest monthly decline since August 2019, when the US Department of the Treasury designated China a currency manipulator.

Contributing to the sizeable depreciation of CNY in August were persistent US dollar strength and surprise interest-rate reductions in PBoC open market operations (OMO), as well as on multiple local instruments, such as MLFs and LPRs. The authorities have taken measures to signal unease with the fast-paced depreciation, however. The counter-cyclical factor (CCF), which had been suspended since October 2020, has been redeployed since the end of August. CCF refers to the spread between the daily USDCNY fixings and implied levels. A strong CNY fixing, typically ranging from 100 to 300 pips versus implied levels, may be interpreted as the PBoC signaling intent to slow CNY depreciation. Also this week, the reserve ratio on foreign currency deposits was reduced to 6% from 8%.

Despite the PBoC's intent, its signaling is a rather blunt tool to curb CNY depreciation pressure, in our view. Measures that effectively increase funding and trading costs are likely to have greater and more immediate short-term impact. One straightforward way is to tighten onshore and offshore funding costs, though this may create unintended consequences and disrupt normal funding operations in the interbank system. Another is to invoke the reserve ratio on FX forwards trading. The PBoC has twice raised the reserve ratio on FX forwards, from 0% to 20% in September 2015 and in August 2018, to curb depreciation pressure.