The USD rallied strongly against the CNY, reaching levels close to last year's high of 7.3274, fuelled by the continued upward momentum of the USD. This surge in the greenback can be attributed to the previous day's increase in US yields, driven by the unexpectedly robust ISM services survey for August. This data has instilled greater confidence among investors in the anticipated third-quarter growth surge in the United States. The significant divergence in economic performance between the US, which is experiencing an upswing, and China and Europe, where growth is decelerating, is a key driver behind the sustained appreciation of the US dollar.
The latest ISM services survey revealed an unexpected rise of 1.8 points in business confidence, reaching 54.5, the highest level since February. Additionally, the employment and prices paid sub-components both registered favourable increases of 4.0 and 2.1 points, respectively. These developments prompted a recalibration of expectations in the US rate market, with a higher likelihood now placed on a final interest rate hike later this year and a reduced expectation for rate cuts in the following year. The probability of a near-term Federal Reserve rate hike has moved closer to a 50:50 call, and the expected number of cuts by the end of the next year has decreased to approximately 88 basis points. Notably, almost one 25 basis point rate cut has been removed from expectations since the disappointing NFP report at the beginning of the month.
The momentum of the USD’s surge could intensify if the USD/CNY exchange rate surpasses last year's high. Recent reports from Bloomberg highlight the continued commitment of Chinese policymakers to support the renminbi in order to mitigate its depreciation. The People's Bank of China (PBoC) has consistently set the daily renminbi reference rate stronger than expected for 54 consecutive trading days, marking the longest period of unexpected daily fixes since Bloomberg began its survey in 2018. However, these measures alone may not be sufficient to counteract the upward pressure on the USD/CNY, especially as the US dollar gains strength more broadly, unless there is an improvement in investor sentiment regarding China's economic prospects.
The most recent trade report from China, released overnight, did show some modest improvements in August but fell short of significantly easing concerns about China's economic growth. The report revealed that annual export and import contractions had moderated to -8.8% and -7.3%, respectively. China's trade surplus has remained relatively stable at USD 863 billion over the past year. There is growing speculation that Chinese policymakers may eventually allow for a more substantial devaluation of the renminbi to stimulate growth through net trade. However, their actions so far indicate a preference for a gradual depreciation path, as they are cautious about triggering a sudden surge in capital outflows.
