FOREX REVIEW: weak dollar weak demand

The renminbi has strengthened against the US dollar over the past week even as fresh Chinese data have pointed to weak domestic demand, highlighting how much of the move has come from weakness in the dollar rather than improving confidence in China’s economy. USD/CNY closed Friday at about 6.7205, down from 6.7451 on August 14, a fall of 0.0246 or 0.36%, meaning the RMB strengthened. The dollar has fallen broadly as investors have worried about US fiscal policy, rising government debt and the Federal Reserve’s next steps.

The People’s Bank of China has appeared comfortable with gradual RMB appreciation but has continued to signal that stability, rather than a rapid rise, remains its priority. Its daily USD/CNY fixing moved from 6.7878 on August 14 to 6.7817 on August 21, despite some day-to-day reversals, broadly following the stronger currency.

At the same time, the PBOC has avoided using lower interest rates to respond aggressively to China’s slowing economy. Benchmark loan rates were left unchanged for a 15th consecutive month on Thursday despite weak industrial production, retail sales and credit demand. That restraint reduces downward pressure on the RMB and suggests policymakers remain wary of squeezing banks’ already-thin profit margins while relying more heavily on fiscal spending to support growth.

The RMB’s gains have been much less impressive outside the dollar pair. The PBOC’s EUR/CNY fixing rose to 7.8906 on Friday from 7.8017 a week earlier, meaning the RMB weakened about 1.14% against the euro. GBP/CNY rose to 9.2101 from 9.1262, a decline of roughly 0.92% for the RMB against sterling. Both currencies have benefited from the broader retreat in the US dollar, with the euro and pound reaching multi-month highs during the week.

The week has therefore offered only limited evidence of stronger confidence in China itself. The RMB has benefited principally from an international move away from the dollar, while weak Chinese credit and consumption data continue to argue against a strong domestic recovery. Investors will now watch whether the PBOC continues allowing gradual appreciation and, especially, whether Federal Reserve Chair Kevin Warsh’s Jackson Hole speech shifts expectations for US rates and reverses some of the dollar’s recent losses.