The yuan rose to 6.3682 against the dollar on May 31, the highest level since the trade dispute between China and the United States. The author believes that the strengthening of the RMB is not the result of the policy change, and the strength of the RMB has also peaked. Although further Sino-US trade negotiations in the future could lead to upward risks to the RMB in 2022 (or even earlier)At this stage, we still predict that the RMB against the US dollar will remain in the range of 6.4 to 6.6 in 2021.In 2022, the yuan may rise another 3.5% against the dollar compared with the same period last year.

If the continued strengthening of the renminbi could prompt the central bank to intervene in foreign exchange, the resulting liquidity could help China's economic growth and boost the Chinese stock market, offsetting the upward risk of yields caused by deleveraging.

Why is the RMB so strong?

The main reasons for the recent strengthening of the RMB are:

1. Current account surpluses and strong portfolio inflows were the fundamentals supporting the strength of the renminbi, with northward inflows to the Shanghai-Hong Kong Stock Connect hitting a record in late May.

2. The dollar has been weakening since April, with the dollar index giving up all its gains so far this year.

3. Since May, some comments from officials that China should let its exchange rate rise to cope with the inflationary impact of rising commodity prices have also had an impact on the renminbi.

But Liu Guoqiang, vice president of the people's Bank of China, rebuffed the comments bluntly several times in late May. In addition, the people's Bank of China sent a clear signal to raise the foreign currency reserve ratio of domestic Chinese banks by 2 percentage points to 7 per cent, reducing the domestic supply of US dollars.

Exchange rate strength has peaked

As the bond yield spread narrowed (figure 1), the CFETS RMB exchange rate strengthened beyond the 91-96 range after the Sino-US trade dispute and approached a high of 98 (figure 2), the growth gap between China and the rest of the world narrowed, and the trend of the renminbi was further affected by the verbal intervention of the central bank. It is uncertain how long the dollar's weakness will last, especially as there are growing rumors that the Fed may start to scale back, which could reverse the dollar's trend.The above market changes also support our view that the strength of the renminbi has peaked.

It is worth noting that DXY, CNY-USD and CFETS have all returned to the level before the trade dispute, which has a great impact on the trend of RMB, which also means that the future development of Sino-US trade negotiations will affect the trend of RMB foreign exchange.

Figure 1. The yield difference between three-year Chinese Treasuries and US Treasuries

Figure 2. RMB trade-weighted exchange rate index (CFETS)