FX Views:A Structural Break in the RMB Fixing Mechanism since Nov.8

1. We regularly track the fixing mechanism for the RMB, using two models. The firstlinks daily changes in the $/CNY fix to previous day changes in the Dollar versus themajors, allowing for asymmetry in how the fix responds to up versus down moves inthe greenback. This model essentially estimates a reaction function for the fix withrespect to the Dollar, focusing on whether Chinese policy makers are biasedtowards RMB strength or weakness. When we first published this model in lateOctober, it explained on average 70 percent of daily fix variation and revealedasymmetry in the direction of a weaker RMB (“Downside RMB Asymmetry“, FXViews, October 28, 2016). The second adds the percent change of the previous day’s$/CNY close vis-à-vis the fix to this model and is therefore closer to the official fixingmechanism the authorities say they have followed since March 2016. This modelaccounted for 90 percent of the daily variation in the fix as of early November,validating the rules-based approach of the authorities (“Exploring the RMB FixingMechanism“, Global Markets Daily, November 1, 2016). This FX Views updates ourestimates, finding evidence of a structural break in the RMB fixing mechanism intwo areas: (i) the R-Squared of the second model has fallen to 80 percent since theelection, as more discretion has crept into the fixing, especially with respect to theprevious day’s close; and (ii) our asymmetry result has flipped, showing that Chinesepolicy makers have been biased in favor of RMB strength since Nov. 8. These resultsare complementary and in our view amount to China’s policy makers putting theirbest foot forward as they await the new administration, though it is also possiblethey are trying to slow capital outflows via stronger RMB fixings. In either case,some RMB weakness is likely being “stored up,” in line with the CFETS baskethaving appreciated since Nov. 8. Coupled with our view that China’s balance ofpayments is weaker now than a year ago (“China’s Balance of Payments OutlookDeteriorates“, Global Markets Daily, January 3, 2017), this validates our bearishoutlook and supports our short RMB top trade for 2017 (“Top TradeRecommendations for 2017,” Global Viewpoint, November 17, 2016).