Renminbi Appreciation: A New Driving Force for Monetary Easing in the Short Term

After the interest rate cut and reserve requirement ratio reduction in May, interbank funding rates have gradually declined, with the overnight and 7-day repurchase rates currently close to 1.5%. In the medium term, whether funding rates can further decline depends on the economic situation. If the economy faces downward pressure, then the interest rate cut in Open Market Operations (OMO) will still drive down the repurchase rates. Although the probability and market expectation of another interest rate cut and reserve requirement ratio reduction within the year remain strong, the pace will not be so fast, as the cuts were just implemented in May.

We believe that in the short term, another factor driving liquidity easing that needs attention is that under the backdrop of RMB appreciation, the People's Bank of China (PBOC) may loosen RMB liquidity to avoid significant appreciation of the RMB.

After the escalation of global trade frictions in April, the RMB only depreciated in the short term before starting to appreciate. The short-term appreciation of the RMB is driven by several factors:

(1) After the escalation of trade frictions, the US dollar has shown a trend of decline. On one hand, market concerns about the US economy have intensified due to the worsening trade frictions, and on the other hand, the US debt issue has also affected the exchange rate. Recently, Moody's announced a downgrade of the US sovereign credit rating. Therefore, since April, there has been a situation of rising US Treasury yields and a declining US dollar index. The underlying logic is the increasing market concern over US dollar debt. If a downward trend in the US dollar exchange rate forms, it may lead to a passive appreciation of the RMB.

(2) Although recently the bond yields of major countries have rebounded and RMB bond yields have declined, the interest rate spread has not put pressure on the RMB exchange rate. In fact, recently, Japanese bond yields have also shown a significant rebound, but the yen has depreciated against the RMB. This indicates that the recent changes in interest rate spreads are no longer the key factor dominating the exchange rate.

In the current economic environment, significant depreciation of the RMB is undesirable, but is appreciation acceptable? Clearly, it is also not very acceptable. After all, under weak trade expectations, appreciation will put greater pressure on foreign trade. Therefore, when there was significant depreciation pressure last year, the PBOC continuously issued central bank bills in the Hong Kong market to absorb offshore liquidity, thereby supporting the exchange rate. Since the beginning of this year, the significant decline in offshore market funding rates reflects the PBOC's efforts to reduce the pressure of RMB appreciation. This is true for the offshore market, and the onshore market also faces liquidity easing due to the PBOC's desire to prevent the RMB from appreciating too quickly.

Note: This article has been abridged.

Authors of this article: Qu Qing, Zhu Dejian, Source: Qu Qing Bond Forum, Original Title: "RMB Appreciation: A New Driving Force for Liquidity Easing in the Short Term - Huachuang Investment Advisory Department Bond Daily 2025-5-21"

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