Can A Sustain Period of Equity Inflows Lead To CNY Strength in MT?

• Implied volatility on CNY has been rising in March, with USDCNY consolidating higher, mostly driven by the increase in selling pressure on the offshore yuan (rather than weaker-than-expected PBoC fixing).
• USDCNH has been retracing gradually higher in the past week, approaching its ST resistance at 6.40. Key level to watch remains at 6.41, which corresponds to the 200DMA (rejected on March 15).
• According to a former SAFE official, the CNH weakness is a sign that foreign investors are starting to sell their Chinese assets and that the tighter policy in the West could continue to lead to portfolio outflows and therefore further CNH depreciation.
• The top chart (source: IIF) shows that China has been experiencing ‘significant’ capital outflows (equity) in recent weeks (biggest in the past cycle), while the rest of EM has been getting inflows.
• However, equities have regained investors’ confidence in the past two weeks following theheadline that regulatory authorities are ‘mulling measures to jointly crackdown earlier this month (March 15). The Hang Seng index is up over 20% since its low.
• Therefore, new equity inflows could lead to CNY appreciation in the short/medium term if the momentum remains firm.
• In addition, as CNY offers interesting carry, the ‘search for yield’ could also be a factor leading to further CNY strength if geopolitical uncertainty eases in the medium term.
• Due to its attractive yield, CNY remains a ‘traditional risk on’ currency that appreciates when volatility eases (bottom chart).

Source: Bloomberg/MNI/IIF.