China and Hong Kong Forex Market Developments One-way appreciation carrying into the new year

China and Hong Kong Forex Market Developments One-way appreciation carrying into the new year January 218 Monthly publication Alicia Garcia Herrero Chief Economist Asia Pacific +852 39-868 alicia.garciaherrero@natixis.com Jianwei Xu Senior Economist +852 39-834 jianwei.xu@natixis.com Kathleen Chen +852 39-8592 kathleen.chen-ext@natixis.com

Key messages The RMB entered the new year on a very rapid appreciation as the USDCNH breached 6.35 for the first time since August 215. A weak dollar is a large part of the story as the dollar index has declined 3.4% in 218 but not all. The domestic environment is also supportive in terms of tamed capital outflows, robust exports and strong GDP growth. The CFETS RMB Index is relatively stable and the CNY has depreciated 3% against the euro in 218 so far. Interbank rates, especially 1M SHIBOR, softened significantly amid improved liquidity conditions in the beginning of the new year. The PBoC drained CNY35bn through OMOs in December to mop up the liquidity stemming from government deposits flooding into banks at year-end. However, liquidity was injected more generously since January. There is a risk of interest hike as a response to deleverage pressure and the Fed normalization, but the pace of the hike should be slow to maintain the growth momentum. FX reserves built up to USD314bn helped by a positive valuation effect as all major currencies appreciated against the USD and improved market sentiment. Capital outflows in terms of the FX positions held by banks / clients increased on the margin in December, which shows some preference for RMB by domestic private sector. We expect the current one-way appreciation to continue in the near term, but some correction of the currency should arrive in the next few months, due to the larger divergence between in monetary policy between PBoC and FED (as we do not expect the PBoC to fully transfer the FED hikes as what has been in the past few cases). Furthermore, down the road, economic fundamentals do not support the one-way appreciation of the RMB. In fact, the upside potential of the USDCNY is limited by an expected deceleration in China s growth, mainly led by investment. It will, thus, be difficult for China to allow for a substantial reduction in the current account surplus. Hence we expect the RMB to slightly depreciate towards the second half of 218. 2

Tables of contents 1. CNH market CNH, CNY and spread CNH HIBOR and CNH forward curve CSS curves FX Reserves and net conversion of FX by banks and clients 5 6 7 8 2. CNY market CNH HIBOR, SHIBOR and Repo 7 CNY and trading band CFETS RMB Index CNY forward curves and NDF SHIBOR and sovereign yields PBoC open market operations 1 11 12 13 14 15 3

1. Key Development (CNH) 4

The RMB entered the new year on a positive note and the USDCNH breached 6.35 for the first time since August 215. 7. 6.9 6.8 6.7 6.6 6.5 6.4 6.3 6.2 CNH and CNY Spread, CNH-CNY (RHS) USDCNY USDCNH.25.2.15.1.5. -.5 6.1 -.1 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 7. 6.95 6.9 6.85 6.8 6.75 6.7 6.65 6.6 6.55 6.5 6.45 6.4 6.35 6.3 CNH and CNY (short timeframe) Spread, CNH-CNY (RHS) USDCNY USDCNH Dec Jan FebMar AprMay Jun Jul Aug Sep Oct Nov Dec Jan.25.2.15.1.5. -.5 -.1 Positive spread indicates offshore yuan is weaker than onshore. Positive spread indicates offshore yuan is weaker than onshore. USDCNH CNH Depreciation (-,%) End of Period High of Period Low of Period January (till 25 th ) +2.88 6.3267 6.535 6.3267 December 217 +1.47 6.5143 6.6279 6.5143 216-6.2 6.9761 6.9761 6.4561 5

The interbank rates softened in the new year. The appreciation expectation for the RMB continue to build up in the market. CNH HIBOR USDCNH forward 8 7 6 5 4 3 2 1 22-Jan-18 22-Dec-17 1-Nov-17 9-Oct-17 ON TN 1W 2W 1M 2M 3M 6M 9M 1Y 5 5 4 4 3 3 2 2 1 1 7.4 7.3 7.2 7.1 7. 6.9 6.8 6.7 6.6 6.5 6.4 6.3 22-Jan-18 1-Dec-17 1-Jun-17 3-Jan-17 Spot 1M 3M 6M 12M 7.4 7.3 7.2 7.1 7. 6.9 6.8 6.7 6.6 6.5 6.4 6.3 6 6

The CNH CCS rates normalized with the short-end rates declined but the long-end yield further dropped. CNH/USD CCS CCS Curves 16 CCS CNH 6M CCS CNH 1M 16 4.4 1/1/218 12/1/217 11/1/217 14 12 1 8 6 14 12 1 8 6 4.2 4 3.8 3.6 4 4 3.4 2 1-Dec 1-Jan 1-Mar 1-Feb 1-Apr 1-May 1-Jun 1-Jul 1-Aug 1-Sep 1-Oct 1-Nov 1-Dec 1-Jan 2 3.2 3 1M 2M 3M 6M 9M 1Y 2Y 3Y 4Y 5Y 7Y 1Y 7

FX reserves built up to USD314bn helped by positive valuation effect and improved market sentiment. Capital outflows in terms of the FX positions held by banks / clients only increased on the margin in December. 15 1 5 China FX Reserves and Currency Spread Reserves (mom change, US$ bn) Spread (CNH-CNY, bps, rhs) 8 6 4 2 15 1 5 Change of FX position of banks and their clients (USD bn) Change of FX position of banks Change of FX position of banks' clients Total change, negative implies less FX held by banks and their clients 15 1 5-5 -1-15 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17-2 -4-6 -8-5 -1 Reduced FX held -15 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17-5 -1-15 8

2. The onshore market (CNY) 9

Interbank rates, especially 1M SHIBOR, softened significantly amid generous liquidity injection by the PBoC and improved liquidity condition in the beginning of the new year. 8. 7.5 7. 6.5 6. 5.5 5. 4.5 4. 3. 1-Feb 1-Mar 1-Apr CNH HIBOR and SHIBOR HIBOR CNH 6M HIBOR CNH 1M SHIBOR 6M 1-May 1-Jun 1-Jul 1-Aug 1-Sep SHIBOR 1M 1-Oct 1-Nov 1-Dec 1-Jan 8. 7.5 7. 6.5 6. 5.5 5. 4.5 4. 3. 5. 4.5 4. 3. 2. SHIBOR 22-Jan-18 22-Dec-17 1-Nov-17 9-Oct-17 ON 1W 2W 1M 3M 6M 9M 1Y 5. 4.5 4. 3. 2. 1

The USDCNY reached a two-year record low at 6.35 amid dollar weakness and supportive domestic environment including tamed capital outflows, robust exports and GDP growth. 7.2 7. 6.8 CNY and Trading Band Spread (CNH-CNY, rhs) USDCNY Trading Band.2.15.1 7.2 7.1 7. 6.9 CNY and Trading Band (short time frame) Spread (CNH-CNY, rhs) USDCNY Trading Band.2.15.1 6.6 6.4.5 6.8 6.7.5 6.2 6. -.5 6.6 6.5 6.4 -.5 5.8 Jan-15 Jun-15 Nov-15 Apr-16 Sep-16 Feb-17 Jul-17 Dec-17 -.1 6.3 1-Aug 1-Oct 1-Dec 1-Feb 1-Apr 1-Jun 1-Aug 1-Oct 1-Dec -.1 USDCNY CNY Depreciation (-,%) End of Period High of Period Low of Period January (till 25 th ) +5 6.3275 6.5297 6.3275 December 217 +1.55 6.568 6.6215 6.568 216-6.95 6.945 6.9615 6.4536 11

The CFETS RMB Index is relatively stable and the CNY has depreciated 3% against the euro in 218 so far. 98 97 96 95 94 93 92 91 9 CFETS RMB Index (214=1) and USDCNY Dec-16 Mar-17 Jun-17 Sep-17 Dec-17 CEFTS RMB Index USDCNY (inverted) 6.3 6.4 6.5 6.6 6.7 6.8 6.9 7 THB 2.9% GBP 3.2% SGD 3.2% MYR 3.8% HKD 4.3% Source: CEFTS, Natixis RUB 2.6% CEFTS RMB Index Composition CAD 2.2% AUD 4.4% Others 1% KRW 1.8% JPY 11.5% USD 22.4% EUR 16.3% CFETS RMB RMB Depreciation (-,%) Last High Low January (till 25 th ) +.58 96.12 96.12 95.13 December 217 +1.11 95.58 95.58 94.52 216-6.13 94.72 1.4 93.67 12

Forward rates moved down from last month. RMB forward curves NDF curves 7. 6.9 CNY (22 Jan 18) CNY (1 Dec 17) CNH (22 Jan 18) CNH (1 Dec 17) NDF (22 Jan 18) NDF (1 Dec 17) 7. 6.9 7.4 7.2 6M NDF 3M NDF 12M NDF 7.4 7.2 6.8 6.7 6.6 6.8 6.7 6.6 7. 6.8 7. 6.8 6.5 6.5 6.6 6.6 6.4 6.4 6.4 6.4 6.3 Spot 1M 3M 6M 12M 6.3 6.2 6.2 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 13

China sovereign yields at the short end softened compared to a month ago along with improved market sentiment and liquidity condition. But the 1Y bond yield still lingers close to the 4. threshold. 5. SHIBOR fixing yield curve (%) 5. 4.5 Sovereign yield curve (%) 4.5 4.5 4.5 4. 4. 4. 4. 3. 1/22/218 12/22/217 3. 3. 1/22/218 12/22/217 3. 2. 1W 2W 1M 3M 6M 9M 1Y 2. 2. 1Y 3Y 7Y 1Y 3Y 2. 14

1/16 2/16 3/16 4/16 5/16 6/16 7/16 8/16 9/16 1/16 11/16 12/16 1/17 2/17 3/17 4/17 5/17 6/17 7/17 8/17 9/17 1/17 11/17 1/29/217 2/19/217 3/12/217 4/2/217 4/23/217 5/14/217 6/4/217 6/25/217 7/16/217 8/6/217 8/27/217 9/17/217 1/8/217 1/29/217 11/19/217 12/1/217 12/31/217 1/21/218 The PBoC becomes more generous in the new year. There is a risk of interest hike as a response to deleverage pressure and the Fed normalization, but the pace of the hike should be slow to maintain the growth momentum. 3.25 3 2.75 2.25 PBoC OMO rates (%) 7D reverse repo MLF 1yr 28D reverse repo 3.25 3 2.75 2.25 15 1 5-5 -1 China PBoC Weekly Open Market Operations (CNY bn) SLO Matured Reverse Repo Matured Repo Turnover SLO Issue Reverse Repo Turnover Repo Matured MLF SLF Net 2 15 1 5-5 -1 2 2-15 -15 Net injection CNY (bn) November 217 +57.2 December 217-349.8 January 218 (till 25 th ) 214.5 15

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