Why is 'cracking seven' a big deal for China's currency?
If China's renminbi slips past Rmb7 a dollar — "cracking seven" in trader talk — it would take the currency to a level of weakness not seen since the depths of the global financial crisis 11 years ago.
It would also breach a widely recognised floor that China's central bank has previously defended during bouts of sharp depreciation last year and in 2016.
The defence mounted in 2016, in which China was forced to burn through some of its foreign exchange reserves, spending as much as US$107 billion ($163.3b) in a single month, followed a shock devaluation from the previous August that marked the currency's biggest one-day drop in decades.
While it delivered a shot in the arm to the country's export-led economy, it spurred substantial capital outflows and drew accusations of currency manipulation from critics in Washington and put it under regular scrutiny from the US Treasury Department.
Fast forward to this year, and following a tumble in early May after US president Donald Trump threatened higher duties on Chinese goods as part of the 11 month-long Sino-US trade dispute, the renminbi has largely halted its fall in the lead-up to the G20 summit in Osaka at the end of this month.
The meeting is probably the final chance for the two countries' leaders to thrash out a deal that would avoid the US levying 25 per cent tariffs on virtually all goods imported from China.
How does China manage the renminbi?
Since 2015 the onshore renminbi exchange rate has been allowed to move 2 per cent in either direction of a daily trading band midpoint set each morning by the People's Bank of China.
When Trump threatened higher tariffs in May, the midpoint soon softened enough to push the weak end of the trading band past Rmb7 per dollar, where it remains, ostensibly permitting the currency to fall past the threshold at a moment's notice.
Beijing also permits a smaller pool of the currency to trade in Hong Kong, part of a drive to internationalise the renminbi. The offshore exchange rate is not limited by the trading band and is therefore subject to the sway of international market forces.
But while a gap between the two rates has opened in recent weeks there is far less daylight between them now than was seen following the shock devaluation in 2015.
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On Tuesday the PBoC announced it would issue renminbi debt in Hong Kong, prompting speculation it was seeking to sop up liquidity there and defend the currency by making it more difficult for international investors to bet against.
But Mansoor Mohi-uddin, senior macro strategist at NatWest Markets, said this was unlikely to have been the main goal of the issuance, since onshore demand for the dollar in China was probably driving markets, rather than offshore short selling.
What does the Trump administration think?
The US Treasury Department again declined to label China a currency manipulator last month, although it expressed "significant" concerns over the exchange rate, then closer to the seven level than at any point since 2008.
But on Saturday, at a meeting of financial ministers and central bank governors in Osaka, ahead of the G20 meeting, US Treasury secretary Steven Mnuchin appeared to suggest that a failure to intervene could itself be viewed as a sort of manipulation.
"Sometimes if the market expects intervention and you've been intervening for a long time to support a currency, and you don't intervene, that could also have a big market impact," he said.
Is seven a matter of if, or when?
Although the renminbi hit a six-month low against the dollar on Monday, many strategists are sceptical it will crack seven before the G20 and on Thursday the onshore rate was just 0.1 per cent weaker on the day at Rmb6.9218 a dollar.
Christy Tan, head of markets strategy and research for Asia at NAB, said the PBoC was unlikely to use devaluation as its weapon of choice when dealing with trade issues. The central bank has not forgotten the hard lessons learnt from the capital outflows and international criticism it weathered in 2015.
But she added that if no deal was struck at G20 and Trump did go all-out with 25 per cent tariffs on the remaining US$300b in Chinese imports, "seven will break through in very short order".
Recent comments from Chinese officials have laid the groundwork for that, downplaying the importance of the seven threshold. On Friday central bank governor Yi Gang said no hard limit existed for the dollar exchange rate.
"I don't think this is an important question," Yi said in an interview with Bloomberg News. "I don't think along the mathematical scale any one number is more important than the other number," he added.
Yi's attention is arguably focused elsewhere. Homin Lee, Asia macro strategist at Lombard Odier, said that the key lower bound for the renminbi was not seven per dollar, but rather 92 — that is, the implicit lower bound for the CFETS Renminbi index, which measures the currency against a basket of peers. The latest weekly reading for the gauge left a bit of breathing room yet at just over 93.
"They have already shown willingness to defend this implicit lower bound, and if they remove that lower bound . . . then there's no obvious anchor for the markets," Lee said.
Written by: Hudson Lockett and Robin Harding
© Financial Times