The theory of the US dollar peaking has ignited Wall Street! Expectations of RMB rebound or range fluctuations | Market | Range

Affected by lower than expected GDP data, the Chinese yuan weakened against the US dollar on Monday, with a decline of 300 points. However, due to the US dollar index experiencing a Waterloo in the past two weeks and rapidly falling below the 100 mark, the Chinese yuan still trades below 7.2 against the US dollar.

As the US dollar experienced its worst week in eight months last week, the theory of a peak in the US dollar ignited on Wall Street, with bearish US dollar positions surging over the past two weeks, with the euro, yen, and pound all taking off against the US dollar. Bears are betting that US inflation will continue to decline, with July being the last interest rate hike and a rate cut in 2024 imminent. In the future, the direction of this debate will not only affect the logic of asset allocation in major categories, but also profoundly affect the trend of the renminbi.

In the medium term, a weakening of the US dollar is the mainstream view, but the short-term US dollar index may have been oversold. "Two weeks ago, before the release of the US CPI report, we had been advocating for investors to continue holding long exposure to G10 non US dollar currencies against the US dollar, but after the US dollar experienced a sell-off, we are now urging investors not to be 'too excited'," said Thermoklis Fiotakis, head of foreign exchange research at Barclays, in an email to reporters

Is the theory of the US dollar peaking reliable

Last week, the index tracking the US dollar against a basket of six currencies fell by 2.2%, the worst trend since a 4.1% drop in the week on November 11th last year. As of 18:20 Beijing time on July 18th, the US dollar index was at 99.4.

In this context, other types of assets around the world are experiencing a frenzy, with the renminbi rebounding strongly against A-shares and Hong Kong stocks. The offshore renminbi has achieved seven consecutive rises, and on July 14th, it briefly stood at 7.13 during the trading session. European and American stock markets have also seen gains, with commodities regaining vitality, and oil prices briefly breaking through the $80 per barrel mark.

The reliability of the "peak of the US dollar" theory has become the hottest discussion on Wall Street recently, which will also have a profound impact on the logic of asset allocation in major categories. Because when the US dollar begins to weaken substantially, global funds will turn to high-interest assets for arbitrage, and more will flow into relatively high-risk markets such as emerging markets.

The data shows that the inflation and core inflation data in the United States in June were lower than expected - the unadjusted CPI in June increased by 3% year-on-year, the smallest increase since March 2021; The non seasonally adjusted core CPI increased by 4.8% year-on-year, reaching a new low since November 2021, with an expected increase of 5%. This fueled the bearish position in the US dollar two weeks ago, causing the US dollar index to plummet to the 100 mark, after hovering around 102 previously.

The probability of an economic recession in the United States has decreased, and inflation has also cooled as scheduled. The expectation of a "soft landing" has skyrocketed, which is conducive to global economic and risk market sentiment. US dollar bears have started to attack early.

Jerry Chen, senior analyst at Jiasheng Group, told reporters that the US dollar performed poorly last week, and non US dollar currencies were encouraged by the Federal Reserve's claim that it is winning against inflation. Although the US dollar received some hype last Friday morning, it was only because there was no new news that traders were forced to liquidate some profits.

"The University of Michigan Consumer Confidence Index and Inflation Expectation Index released in the afternoon of the same day were higher than predicted. The one-year inflation expectation was 3.4%, with a predicted value of 3.1%, indicating that inflation may still be difficult to deal with and that tightening monetary policy will take longer to implement. Therefore, we see the US dollar rebounding against currencies such as the Japanese yen, with the US dollar index slightly rising. The US dollar is clearly oversold, for example, the RSI indicator is below the 'oversold' threshold of 30 on the daily chart."

At present, there is not much controversy among institutions regarding the mid to long term peak of the US dollar, but it remains to be seen whether there is excessive market sentiment in the short term.

For example, Ulrich Leuchtmann, head of foreign exchange and commodity research at Commerzbank Germany, told reporters that short the US dollar based solely on the expectation of no further interest rate hikes after the July meeting is insufficient. In fact, the interest rate hike in July has become an insignificant event.

In his view, the reasons include two aspects - firstly, the expectation that July may be the last interest rate hike has been fully priced by the market, and there is no reason to believe that this expectation will have a negative impact on the US dollar; Secondly, in terms of the euro, there are potential factors of disappointment in the market's expectations of the European Central Bank continuing to aggressively raise interest rates. Therefore, there may be a correction in the exchange rate of the euro against the US dollar. This means there are not many reasons to sell dollars in the short term.

In the medium term, institutions believe that a peak in US Treasury yields may mean a peak in the US dollar, and the market will seize the opportunity to lay out currencies such as the euro and yen. It is not difficult to see that the euro has quickly broken through the 1.1 level against the US dollar in the past week, and is currently trading at 1.12.

"We expect that on July 6, the yield of US treasury bond bonds has peaked across the board, which is very significant from a technical point of view. On July 6, the yield of two-year US treasury bond once went out of its annual high, 1 BP higher than the previous high, and then fell back about 50 BP." Robson, the global chief strategist of Standard Chartered, told reporters that as the market began to cut short positions in low yield currencies, such as the short position in the yen, the value of these currencies might rise significantly at the initial stage, the increase could be comparable to that of high-yield currencies, and then capital might flow back into emerging market assets.

"The euro may not be considered a high yield currency, but as the depreciation of the US dollar affects more currencies, the euro has already broken through the 1.05-1.10 range against the US dollar and should perform well. Currently, Eurozone government bonds provide positive yields across the board, and we expect that the investment portfolio of foreign exchange reserves in various countries may significantly increase the allocation of the euro. Currently, the euro accounts for 19.77% of global foreign exchange reserves, only higher than the cyclical low of 19.14% in December 2016, while the US dollar accounts for 59%. We believe that the market underestimates the potential scale of foreign exchange reserves transitioning from the US dollar to the euro.".

The RMB tends to fluctuate within a certain range

In the past two weeks, the Chinese yuan has significantly rebounded, approaching a rebound of 1000 points from its previous lowest point. As the Federal Reserve's interest rate hikes come to an end, the US dollar/yuan may peak at the 7.2-7.3 level. But in the short term, institutions believe that range fluctuations may be more likely.

"At present, the interest rate difference between China and the United States is still favorable to the US dollar, and the US dollar will continue to receive support. This means that the US dollar/RMB will maintain a range trading before the July Politburo meeting," said Zhang Meng, a foreign exchange and macro strategist at Barclays, in an email to reporters.

In the past two weeks, the reason why the Chinese yuan has rebounded significantly is not only because the US dollar has peaked and fallen, but also because investors have clearly observed changes in the attitude of Chinese regulatory authorities.

Zhang Meng told reporters, "The regulatory authorities have further strengthened their guidance on the RMB exchange rate after the end of the Dragon Boat Festival holiday. We have observed a series of stronger than expected daily midpoint settings, with state-owned banks selling US dollars before the domestic market closes and lowering US dollar deposit rates twice in recent weeks. In addition, driven by the decline in the US dollar index, this has effectively limited the decline of the RMB." She also mentioned that this has also discouraged some market participants who have been adopting a buy back strategy, and some have turned to holding long positions in Singapore dollars against offshore renminbi.

In this round, the Chinese yuan depreciated to a level close to 7.3. On June 27th, the deviation of the central parity rate of the Chinese yuan was significant. Several traders and strategists told reporters that the central parity rate released a stable signal on that day, which was more than 100 points stronger than the model's prediction. This is a rare deviation degree since the beginning of this year; The following weekend, the market began to anticipate that the renminbi had entered the bottom range; The news of US Treasury Secretary Yellen's upcoming visit to China also boosted risk sentiment; In addition, at that time, several major domestic banks successively lowered their US dollar deposit interest rates, which helped to reduce spread arbitrage activities.

In Zhang Meng's view, in order to achieve a significant appreciation of the Chinese yuan against the US dollar in the future, Chinese companies need to sell their US dollar receipts, or market sentiment can significantly improve China's economic growth prospects, in order to counter the adverse effects of the interest rate difference between China and the United States. Barclays expects that China may launch a series of stimulus measures to expand its scale later this month, but the magnitude may not exceed market expectations.

In the view of institutions, before these measures take effect, the renminbi may occasionally be negatively affected by the dividend exchange demand of Chinese companies listed in Hong Kong, especially in the days leading up to July 28th. Barclays estimates that the total dividend amount as of July 28th was $2 billion, August 4th was $14.6 billion, and August 18th was $3.4 billion. The CFETS index has depreciated by 3.5% since the beginning of this year, and without the positive impact of export settlement or stimulus plans, the CFETS index may continue to decline.