Historically United States and other countries have always made complaints that China keeps the value of the RMB artificially low, boosting its exports and trade surplus at the expense of trading partners. US has consistently pressured China in the past decade to allow the RMB to appreciate at a faster pace, and to let the currency fluctuate more freely in line with market forces. Cut to present, since CNY broke through it’s 31 month low of 7.00 on 29th Dec, the Chinese currency has now strengthened by 1.4%. That does not sound like a strong appreciation but the fact that it is allowed to happen by Chinese policy makers makes us wonder about their motivations and what is the eventual destination for RMB. From a policy perspective, Xi wants to build an alternate global reserve currency, hence RMB has to be seen as aiding China’s trade partners & not the past pattern of export competitiveness. This has pushed PBOC to allow a gradual appreciation in RMB to current 6.90 levels. But we see an impending flow issue which can move RMB in a non linear manner to 6.5. China created 1.2 TN USD trade surplus in CY2025. We observe that a vast pool of US dollar cash has accumulated in Hongkong. In just two years US dollar deposits in Hong Kong banks have grown by $325 BN to $1.5 TN. Net foreign exchange purchases by Chinese onshore banks amounted to just $197 BN, less than the growth of US dollar deposits in Hong Kong over the same period. The 1.4% rise in RMB against the USD since end CY25 has already eroded most of the yield pick up that Chinese holders of US dollar deposits expected for this year. Now RMB based holders of US dollar deposits have to face the prospect that at this rate of appreciation, it will only be a matter of weeks before they are losing money on their positions. Hence, we expect these US dollar deposits in Hong Kong to start moving inwards to RMB if RMB sustains below 6.85. This will lead to a avalanche of RMB buying further leading to a nonlinear movement towards 6.5. Both from political point of view as well as flow point of view, RMB looks headed to 6.5 levels sooner than later. We have had the same view in many of our earlier fx opinion pieces since RMB was at 7.10. Now with PBOC reluctance to halt the appreciation, our view stands vindicated.
