The recent surge in the renminbi is nothing short of surprising and has left many market analysts scratching their heads!

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Just yesterday, both the offshore and onshore renminbi experienced a significant rally, at one point soaring to 7.09 against the dollar, marking an intraday increase of over 400 points.

Onshore Renminbi

At this moment, the onshore renminbi has nearly returned to its levels from the start of 2024, recovering about seven months' worth of depreciation in merely one month.

As we know, the substantial increase in the renminbi during August was primarily attributed to a sharp decline in the dollar index

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Since August began, the dollar index has dropped nearly 2%, reaching a 13-month low.

However, the sudden jump in the renminbi of 400 points last night is curious.

Firstly, it is essential to note that the dollar index has not experienced any downward movement in the past few trading days; on the very day the renminbi surged, the dollar index actually strengthened by 0.35%. Even the Japanese yen, which contributed to the previous decline of the dollar index, showed no unusual fluctuations; in fact, the yen slightly depreciated that day.

Thus, this wave of renminbi appreciation cannot be merely understood in terms of the previous pattern of “dollar depreciation leading to renminbi appreciation,” but represents a move that stands on its own.

Secondly, there has been a significant hold on the Fed's messaging, as they haven't released any signals indicating upcoming interest rate cuts, while Chinese banks continue their trend of lowering rates.

Following the rate reductions by six major state-owned commercial banks and twelve nationwide joint-stock banks, smaller banks such as Shanghai Bank, Suzhou Bank, Ningbo Bank, Xiamen Bank, and others have followed suit in reducing deposit rates; additionally, various local commercial banks, rural banks, and credit cooperatives have made similar adjustments.

This creates a scenario where, despite a halt in interest rate hikes in the U.S., the renminbi is effectively in a mode of falling interest rates, widening the interest rate differential between China and the U.S

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Even under such conditions, the renminbi has still managed to appreciate dramatically.

This challenges our long-held beliefs about currency movements.

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So what was the real driving force behind the sudden rise of the renminbi yesterday?

It appears that funds are positioning themselves in anticipation of a Fed rate cut in September. This is understandable, as the market has already factored in that the Fed will lower rates in September, leading to a likely decline in the dollar index, which in turn would benefit currencies outside the dollar, prompting traders to preemptively buy renminbi for arbitrage purposes.

Many may wonder where this renminbi appreciation could go, especially with its current rise to 7.1. However, it would be unwise to disregard the upcoming pressures towards renminbi appreciation.

Stephen Jen, the well-known proponent of the “dollar smile theory,” has predicted that if the Fed begins to cut rates, it could lead to over one trillion U.S

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dollars coming back to China, resulting in a potential 10% appreciation of the renminbi.

Jen believes that since 2020, Chinese companies may have accumulated approximately two trillion U.Sdollars in overseas investments, primarily in higher-yielding dollar assetsAs the Fed cuts rates, these dollar assets will become less attractive, prompting some Chinese companies to exchange these dollar assets for renminbi, culminating in substantial renminbi appreciation.

In the first half of this year, our foreign trade exports were remarkably robust, and with the renminbi depreciating from 7.1 to around 7.3, foreign trade companies exhibited a very low willingness to convert to renminbi, opting instead to retain earnings in dollar accounts to take advantage of high-interest rates while borrowing low-interest loans from Chinese banks, engaging in profit-margin plays.

As we move into the second half of the year, the renminbi is climbing sharply, and with year-end approaching, companies will see a peak in their currency conversion needs.

CITIC Securities has made similar predictions, indicating that due to the prior depreciation of the renminbi, companies potentially hold an estimated 8 to 14 billion U.S

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dollars in convertible currency each month; if this pent-up demand is released simultaneously, it could bolster the renminbi’s exchange rate significantly in the short term, possibly by around 1000 points (0.1).

However, there is one crucial prerequisite: the expectations surrounding the renminbi must remain stable.

In my opinion, even if a trillion dollars were to flow back into China, circumstances such as weak consumer spending in China and a reliance on foreign trade for economic support will likely inhibit the renminbi's sustained and significant appreciation in the latter half of the year; moreover, the groundwork for substantial renminbi appreciation rests on economic recovery, which currently appears to be underwhelming