In September, we discussed a dramatic cooling in expectations for appreciation of the RMB. Little or no appreciation in the first nine months of the year led many market actors to change their assumption that RMB appreciation was inevitable. The last three months suggests that this trend is gradually changing as market actors warm up to the RMB again, but significant uncertainty remains.
Throughout much of this year corporations with deposits in domestic banks have been reluctant to exchange their USD for RMB. The growth in foreign currency deposits had a dampening effect on RMB appreciation, reducing the need for the central bank to intervene to slowdown RMB appreciation. Indeed, the RMB actually depreciated on average between May and July.
Now corporations are beginning to reduce the growth of their dollar holdings. The growth of foreign currency deposits peaked in June in absolute term rising by $27 billion. Foreign currency deposit growth has since slowed considerably, and in fact deposits even fell for the first time this year in September.
The change in foreign currency deposit growth is a reflection of the shift towards renewed RMB appreciation. Beginning in August, the RMB resumed appreciation against the dollar, and in subsequent months has appreciated even faster than the annual monthly average for 2011.
The market’s warmer expectation toward the RMB will mean more work for China’s central bank. Foreign exchange reserves began to pick up once again in August and September in line with a rising trade surplus. Although we are still waiting on the October forex reserve numbers, with the trade balance rising to $32 billion in October – the highest this year – it is likely that we will see higher foreign exchange intervention in October.
Many of the very negative market expectations surrounding China’s economic slowdown may be changing. The change is now being reflected in foreign currency deposits and more broadly RMB appreciation expectations. It is still too early to tell if the trend has fully reversed itself with corporations continuing to increase foreign exchange deposits in October. However, if deposit growth falls in November and December this would suggest that expectations surrounding RMB appreciation are more entrenched, and thus reverting back to the trend of the past two years.