CNY: More controls, more weakness - SocGen

According to the analysts at Societe Generale, USD-CNY is expected to grind higher to 7.30 by the end of 2017.

Key Quotes

“The probability of a free floating RMB should rise steeply over the coming years and become a near certainty by end-2019. The probabilities of a free float are 20% in 2017 (but 50% if the US takes major trade actions against China), 50% in 2018 and rise to 80% in 2019.”

“A rising dollar, higher UST yields, and an unrelenting desire for FX diversification by local residents means more depreciation pressure. Beijing’s ultimate goal is to let the RMB reach a market clearing price sooner rather than later, albeit without a major one-off devaluation during the process. This is already challenging enough and now the potential policy mix from the Trump administration has further complicated the task.”

“Capital controls will be tightened further, which may be enough for the PBoC to manage the depreciation pace for a while longer. Given the a large domestic money stock that is still growing much faster than nominal GDP, as well as the increasingly stretched valuations of many domestic assets, it is going to be an uphill battle for the PBoC to retain controls over the speed of currency adjustments. We do not believe that capital controls can have a lasting effectiveness for an economy of China’s size and complexity.”

“Risks – downside exceeds the upside

Capital controls cannot be effectively tightened and the RMB depreciates beyond 7.30. A stronger RMB requires better growth prospects, removal of worries about corporate leverage and the banking system, RMB finds its market clearing levels and FX diversification halts.”