Time to Long USD-CNH Swap Points

The
Chinese currency has been on a rapid upward trajectory since last November.Entering 2023, both CNY and CNH continue the stellar performance, with the 6.70
mark looming in sight.

In the
meantime, the official CNY index also climbed, with the CFETS RMB index back to
the 100 mark. The upside potential, in our view, not only indicates that the
Chinese currency would continue to appreciate, but also implies a sharp
narrowing of USD-CNY forward points.

The
forward points, theoretically speaking, should be a reflection of the interest
rate differentials. From this perspective, as the Fed is about to finalize its
tightening cycle, it makes sense to expect the US-China rates differentials to
narrow, particularly as recession risk is mounting in the US.

From
China’s side, while we do expect further policy easing by the Chinese central
bank in the coming year, improving expectations on economic growth suggests
that market interest rates for CNY are bias to the upside.

All
told, we believe that it is time to enter a long position in USD-CNH forward
points. If history is any guide, we believe the one-year USD-CNH is heading
towards -1,000 pips, from around -1,600 pips currently. Further upside cannot
be discounted.

The
Chinese currency has been on a rapid upward trajectory since last November.Entering 2023, both CNY and CNH continued the stellar performance, with the
6.70 mark looming in sight. China’s swift Covid reopening has significantly
boosted market sentiment, in the meantime, investors have once again embraced
China assets, as the H-share benchmark index has jumped by more than 40% since
last November.

In the
meantime, the official CNY index also climbed, with the CFETS RMB index back to
the 100 mark. However, the overall index is still well below the levels seen in
the majority of 2022, suggesting that the Chinese currency might still have
upside potential if China’s growth momentum accelerates. The upside potential,
in our view, not only indicates that the Chinese currency would continue to
appreciate, but also implies a sharp narrowing of USD-CNY forward points.

The
forward points, theoretically speaking, should be a reflection of the interest
rate differentials. From this perspective, as the US Federal Reserve (the
"Fed") is about to finalize its tightening cycle, it makes sense to
expect US-China rates differentials to narrow, particularly as recession risk
is mounting in the US. While the markets are divided on whether the US economy
will see a recession or a soft landing (as wage growth appears to be slowing),
both point to that a Fed pivot is underway. Therefore, the dollar rates are
likely to have peaked and would go lower, especially in the short tenor that is
more sensitive to monetary policy stance. In the end, this will result in
narrowing USD-CNH swap points.

From
China’s side, while we do expect further policy easing by the Chinese central
bank in the coming year, the improving expectations on economic growth suggest
that market interest rates for CNY are bias to the upside. As credit demand is
likely to increase as economic growth picks up, some sort of liquidity
tightening can be expected as well.

All told,
we believe that it is time to enter a long position in USD-CNH forward points.As the US-China rates differentials for the 10-year tenor have already been
narrowing, we think that the one-year USD-CNH swap points will catch up as
well. If history is any guide, we believe the one-year USD-CNH is heading
towards -1,000 pips, from around -1,600 pips currently. Further upside cannot
be discounted.