The difference in the pace of economic recovery between China and the United States determines that the RMB will not strengthen unilaterally this year, and the difference in monetary policy also determines that it will not weaken unilaterally. This year, the RMB exchange rate may be an "inverted N" or "W" trend, with overall bilateral fluctuations. The reduced QE has not yet been priced in the US bond market, and the renminbi is likely to weaken again. After that, if emerging markets can get out of COVID-19 's shadow, the RMB may strengthen again against the dollar and stabilize or weaken against a basket of currencies.

In the traditional dollar index analysis framework, the economic differences between the United States and Europe and monetary policy differences are the core factors of dollar pricing. The two work together on real interest rates, and empirical tests show that the real spread of virtue can explain more than 70% of the volatility of the dollar index. But there was a brief divergence between the real spread of virtue and the dollar index in the second half of last year due to the outbreak in the United States in the autumn.

Figure 1: after the Spring Festival, the liquidity premium is mostly kept within the range of "neutral loose".

Therefore, in addition to economic and monetary policy, the trend of the COVID-19 epidemic has also become a new driver of the marginal pricing of the dollar index. This year, the United States leads the euro zone in vaccination and economic recovery. It is reflected in the widening of the real interest rate spread in virtue, and the highest rebound in the dollar index to around 93.3. With Europe catching up in epidemic prevention and control and economy, the actual spread of virtue has gradually converged, and the Q2 dollar index has begun to adjust back to around 90.

Figure 2: the difference between the epidemic situation in the United States and Europe since the beginning of the year is a new driver of the trend of the dollar.

Us inflation rose rapidly in April, but the market expects the Fed to put up with short-term inflation until the job gap is close to closing. Us dollar bonds have not yet begun to price the Fed's tightening of monetary policy. If the non-farm payrolls data for May-June show an accelerated recovery in labor supply, expectations of a tight currency will strengthen, when the dollar will most likely rebound along with US Treasury interest rates.

This year, the trend of the US dollar may be "N-type" or "M-type", "first up-then down-then up" or "first up-then down-then up-down". The reason for "going up first" is that the US economic recovery and epidemic control are faster than those in Europe and Japan; the "latter bottom" is due to the accelerated economic recovery in Europe and the extraordinary easing of US money during the period of rising inflation; and the "back up" is because the US employment gap is close to closing, and the market expects the Federal Reserve to reduce QE, while the lagging European and Japanese central bank still maintains the size of QE. Whether it can "go down again" depends on whether emerging markets can emerge from the effects of the epidemic and begin to accelerate their recovery by the end of the year, leading to a spillover of dollar liquidity. Generally speaking, the recovery of non-US economies is more resilient than and later than that of the US.

The dollar model we have built accurately predicts the trend of the dollar's strength before weakness so far this year. The current model predicts that June will be a short-term low for the dollar index, which rebounded slightly in July. The adjusted R Square, INC. in the model sample (2009-2020) is as high as 91.3%, which can explain most of the fluctuations of the US dollar index.

Figure 3: the short-term dollar index model predicts that the dollar index will fall to around 89 in July.

The rapid weakening of the dollar index explains the recent rapid rise in the RMB exchange rate. The exchange rate is not only a reflection of the economic operation of different countries, but also the expected pricing of real gold and silver in the foreign exchange market. Exchange rate manipulation means huge capital and institutional costs, and with the strengthening of the vertical integration of the global value chain, the impact of exchange rate changes on trade is weakening. Therefore, manipulating exchange rate appreciation or depreciation for the sake of import or export is neither in line with common sense nor with the reform direction of RMB internationalization.

Our RMB model signalled a decline in the RMB victory rate in January and March. The RMB victory rate rose again in April and fell somewhat from the previous period in May, but it is still in the appreciation range.

Figure 4: the trajectory of monthly victory and odds of RMB exchange rate since the beginning of this year

Corresponding to the forecast of the trend of the US dollar this year, the trend of the RMB exchange rate against the US dollar this year may also be "inverted N" or "W". Last year, China took the lead in economic recovery and the RMB appreciated; at the beginning of the year, the US economy recovered rapidly, US dollar and US debt interest rates rebounded, and RMB fell; in the second quarter, the US economic recovery slowed, US dollar liquidity spillover, US debt interest rates and US dollar fell, and the RMB appreciated again. After the Fed begins to communicate to reduce QE, the RMB may weaken again. If the non-US economy can emerge from COVID-19 's influence by the end of the year, the RMB may strengthen again against the US dollar and be stable or weak against a basket of currencies by the end of the year.

The pricing of the exchange rate of RMB against the US dollar is still inseparable from the economic differences and monetary policy differences between China and the United States. The difference in the pace of economic recovery between China and the United States determines that the RMB will not strengthen unilaterally this year, and the difference in monetary policy also determines that the RMB will not weaken unilaterally this year, and the RMB exchange rate this year is likely to fluctuate bilaterally.