In the past two trading days, the Chinese yuan suddenly surged. The offshore RMB against the US dollar has broken multiple key levels within two days. Onshore and offshore RMB against the US dollar have risen sharply, both breaking the 7.22 level. Onshore RMB against the US dollar rose more than 550 basis points intraday, while offshore RMB against the US dollar rose more than 450 basis points.

So what happened? Analysts believe there are three main reasons:

• Firstly, the central bank has started to cut interest rates continuously in recent days, and the external market may have begun to brew the expectation of strong domestic economic growth. At the same time, the Third Plenary Session pointed out that the economic target must be achieved during the year. Under the background of weak second quarter, the policy is expected to be strengthened in the second half of the year.

• Secondly, the recent appreciation of the yen, which rose nearly 1% again today and broke through the 153 mark for the first time since May 6, has been closely linked with the renminbi in the past six months.

• Thirdly, the weak dollar. Last night, the S&P Global Manufacturing PMI recorded 49.5 in July, falling below the expected 51.7 and the previous value 51.6, under the boom line. At the same time, the market is still trading Trump. Therefore, the dollar has been constantly weak recently.

Renminbi sudden explosion

Today, onshore and offshore RMB both rose sharply, with offshore RMB against the US dollar accumulating a rise of 300 points intraday, approaching 7.23. In the past two trading days, offshore RMB has broken several key levels such as 7.29, 7.28, 7.26, 7.27, 7.25, and 7.23, and the upward trend is very strong.

Analysts believe that the reason for the sudden surge of the renminbi comes from two directions inside and outside.

Firstly, on July 22, the central bank lowered the OMO rate by 10BP, followed by a 10BP cut in the 1-year and 5-year LPR rates. Today, MLF cut interest rates again. Previously, the market had always believed that the weight in the regulatory aspect of stabilizing the exchange rate was relatively heavy, so interest rate cuts did not occur. However, after the Third Plenary Session, this pressure seems to have been reduced. On the other hand, according to data released by the National Bureau of Statistics, China's GDP in the second quarter of 2024 increased by 5.3% year-on-year, with a growth of 4.7% in the second quarter, lower than the same period last year 6.3%. However, the important meeting proposed that this year's economic growth target of about 5% must be achieved. This was interpreted by the market as the increasing demand for short-term economic growth stability. The reform expectations brought by the Third Plenary Session have also reduced pressure on the exchange rate.

Secondly, the correlation between the yen and the renminbi has increased significantly this year, and the appreciation of the yen often leads to a strong period of the renminbi. Recently, the yen has been very strong, and the USD/JPY has directly dropped from above 160 to below 153. Juntaro Morimoto, senior foreign exchange analyst at Sony Financial, said that as the short position of the yen suddenly closed, the rapid rise of the yen is correcting the previous excessive devaluation. The correlation of the past three years shows that the target for the US 10-year real interest rate and USD/JPY should be around 150, and the yen may rise to this level.

Thirdly, the weak US dollar has contributed to the strength of the renminbi. The S&P Global Manufacturing PMI recorded 49.5 in July, falling below the expected 51.7 and the previous value of 51.6; The S&P Global Services PMI in July was recorded at 56, higher than the expected 55 and the previous value of 55.3; US June new home sales totaled 61.7 on an annualized basis, lower than the expected 64 and the previous value of 62.1. Recent data all point to the marginal decline of the US economy, which further promotes the market's expectation of a rate cut by the Federal Reserve. At the same time, the market is also expecting that Trump will adopt a weak dollar strategy after returning to office to promote the return of manufacturing and commodity exports.

Exchange rate pressure disappears?

So, does the pressure on the renminbi exchange rate disappear?

Analysts believe that the current situation still depends to a large extent on the strength of the US dollar and the yen. Although the recent adjustments of the US dollar index are not significant, this still happened under the background of the sharp rise of the renminbi and the yen.

Global stock markets fell sharply last night. Will this increase market risk aversion also needs to be observed. Matt Simpson, a senior analyst at CMC Markets, told a reporter from Securities Times that the market has entered a safe haven phase, with global indices, commodities and key commodity currencies (such as the Canadian dollar, Australian dollar and New Zealand dollar) all falling. In this context, the US dollar index has not fallen much. An obvious sign is that investors are pouring into cash, because we also see gold and long-term bond prices falling, which raises yields as investors demand higher premiums to hold these risky assets.

In addition, there is the yen. The increase in risk aversion caused by the fluctuation of USD/JPY volatility, stock market declines, etc., is leading to the collapse of yen arbitrage trading. The "Trump deal" being closed and the prospect of the US cutting interest rates due to fears of a slowing economy are also factors that have led to the deterioration of risk aversion.

According to Thursday's pricing, there is a 58% chance that the Bank of Japan will raise interest rates by 15 basis points before July 31, higher than last week's 0.29%. If Japan raises interest rates, the interest rate differential between Japan and the United States will remain around 5 percentage points. Based on current sentiment and data, the appreciation of the yen may continue until the end of this month. The correlation between the renminbi and the yen suggests that the renminbi may also strengthen by then.

It is worth noting that in the first half of 2024, the renminbi played the role of a stable anchor currency in Asia. According to BOC International, the middle prices of the RMB against the yen, won, baht, ringgit and Singapore dollar rose by 12.2%, 6.3%, 6.3%, 2.1% and 1.9% respectively. In addition, on July 19, the People's Bank of China emphasized in conveying the spirit of the Third Plenary Session of the Twentieth Central Committee that it would improve the regulated floating exchange rate system based on the market supply and demand, reference to a basket of currencies, and management, to enhance exchange rate flexibility and maintain the basic stability of the renminbi exchange rate at a reasonable and balanced level. It can be seen that the direction of the market-oriented reform of the renminbi exchange rate and the short-term central bank stable exchange rate policy has not fundamentally changed.

Editor/Emily