All Eyes on USDCNY as It Moves Close to Last Year’s High

USD: US-China growth divergence lifts USD/CNY close to last year’s high overnight, the US dollar continued its upward surge, propelling the USD/CNY exchange rate tantalizingly close to last year's peak at 7.3274. This surge in the US dollar's value can be attributed to the previous day's rise in US yields, triggered by the release of the surprisingly robust ISM services survey for August. This data has bolstered investor confidence in the anticipated Q3 growth spurt in the United States. The stark divergence in economic momentum between the US, which is on an upswing, and China and Europe, where growth is waning, has emerged as a significant driver behind the US dollar's ongoing ascent.

The latest ISM services survey unveiled an unexpected 1.8-point boost in business confidence, reaching 54.5, the highest level since February. Furthermore, the employment and prices paid sub-components both recorded favourable increases of 4.0 and 2.1 points, respectively. These developments prompted the US rate market to recalibrate its expectations, with a higher likelihood now being placed on a final interest rate hike later this year and a reduction in expectations for rate cuts in the following year. The probability of a final Federal Reserve hike in the near term has moved closer to a 50:50 call, and the amount of expected cuts by the end of the next year has dwindled to approximately 88 basis points. Notably, nearly one 25 basis point rate cut has been erased from expectations since the disappointing NFP report at the beginning of the month.

The US dollar's rally could gather even more steam if the USD/CNY exchange rate breaches last year's high. Recent reports from Bloomberg underscore that Chinese policymakers remain committed to shoring up the renminbi to curb its depreciation. The People's Bank of China (PBoC) has consistently set the daily renminbi reference rate stronger than anticipated for the 54th consecutive trading day, marking the longest stretch of unexpected daily fixes since Bloomberg initiated its survey in 2018. Nevertheless, these measures alone are unlikely to counter the upward pressure on USD/CNY, particularly as the US dollar strengthens more broadly and unless there is an improvement in investor sentiment regarding China's economic outlook.

The latest trade report from China, released overnight, did indicate some modest improvements in August but fell short of substantially alleviating growth concerns in China. The report revealed that annual export and import contractions had moderated to -8.8% and -7.3%, respectively. China's trade surplus has remained relatively stable over the past year at USD 863 billion. Speculation has grown that domestic policymakers may eventually permit a more significant devaluation of the renminbi to bolster growth through net trade. However, their actions thus far suggest a preference for a gradual depreciation trajectory, as they remain cautious about triggering a sudden surge in capital outflows.

USD/CNY WITHIN TOUCHING DISTANCE OF LAST YEAR’S HIGH

Source: Bloomberg & Macrobond

CAD & GBP: BoC policy update & BoE Governor Bailey comments in focus

Another significant economic event from yesterday was the Bank of Canada's (BoC) latest policy meeting, although its impact on the Canadian dollar remained subdued. Despite delivering a hawkish hold by keeping the policy rate at 5.00%, the BoC's hawkish guidance couldn't prevent USD/CAD from reaching a new high at 1.3676. In their accompanying statement, the BoC justified their decision to hold rates by citing recent evidence of easing excess demand in the economy and their expectation that past monetary policy actions will continue to affect the economy with a delay.

The release of a much weaker GDP report for Q2, including a downward revision to Q1 growth, has given the BoC more confidence that the Canadian economy is entering a period of slower growth, reducing the necessity for further rate hikes. Nevertheless, the BoC maintained its hawkish stance, signaling its readiness to raise rates in the future. Their primary concern remains the persistence of underlying inflation pressures, which have shown limited signs of abating and are running at approximately 3.5%. Additionally, the BoC noted that headline inflation is likely to rise in the short term due to recent increases in gasoline prices before moderating again.

Overall, the policy update doesn't alter our forecast for the BoC to keep rates unchanged for the remainder of the year. Despite the Canadian dollar weakening against the US dollar, it has outperformed other G10 currencies. Since the dollar index hit its low on July 18th, the Canadian dollar has been the second-best performing G10 currency, supported by the improving US economic outlook and higher oil prices.

Market expectations for monetary policy in Europe were also influenced yesterday by statements from officials at the European Central Bank (ECB) and the Bank of England (BoE). BoE Governor Bailey's comments weighed on the pound, pushing the GBP/USD exchange rate back toward the 1.2500 level and causing EUR/GBP to rise to the 0.8600 level. Bailey explicitly stated that rates are likely "near the top of the cycle," with a "definitely a substantial amount of transmission to come" from past rate hikes. He believes that the transmission in this tightening cycle is longer, and the lags are extended, factors that the BoE must consider in its policy decisions.

These comments, along with those from Chief Economist Pill last week, who favors keeping rates at a higher level for a more extended period rather than continuing to raise them, support our forecast for one final rate hike by the BoE later this month. While the UK rate market had previously expected the BoE to hike the policy rate up to 6.00%, those expectations are now being scaled back, leaving room for disappointment and a weaker pound, with around 50 basis points of further hikes still anticipated.

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