Understanding RMB's 7 Yuan Threshold in 10 Points

This morning, the offshore exchange rate of the Chinese yuan against the US dollar broke through the 7 threshold, with the latest quote at 6.9997 yuan per US dollar.

This marks the first time in 16 months that the yuan exchange rate has returned below 7.

From 7.31 at the beginning of July this year to the current 6.99, the yuan has appreciated by nearly 3,200 basis points in just over two months.

Below, we will use 10 paragraphs to understand this significant financial event.

1. The yuan breaking through 7, the "final touch" was due to several major positive factors yesterday.

These major positives include a 0.5 percentage point reduction in the reserve requirement ratio, in addition to another 0.25 to 0.5 percentage point reduction before the end of the year; a 20 basis point cut in policy interest rates, with the October LPR expected to cut by 20 to 25 basis points; a reduction in existing mortgage interest rates, generally by about 0.5 percentage points (50 basis points); and the down payment ratio for second homes has been reduced to the level of first homes, at 15%.

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There are also three major super positives for the securities industry: it has been officially confirmed that a stabilization fund is being studied (implying that trillions of incremental funds may enter the stock market to support the market); the creation of swaps for securities, funds, and insurance companies to support qualified securities, funds, and insurance companies in obtaining liquidity from the central bank through asset pledges, with a maximum of 1.5 trillion yuan in funds (in three phases); and the creation of special re-lending facilities to support listed companies in repurchasing and increasing their holdings, with a maximum of 0.9 trillion yuan in support.

The release of the above positives means that macroeconomic policies are fully stepping on the gas. But this is just monetary policy, and it is believed that fiscal policy will also be fully effective.

Affected by these positives, the Shanghai Composite Index rose by more than 110 points yesterday, and Chinese concept stocks listed in the United States also rose significantly overnight, with the NASDAQ China Golden Dragon Index surging by more than 9%.2. The breaking of the 7 yuan exchange rate for the Chinese currency implies a significant change in the perception of RMB assets by international capital. The offshore RMB exchange rate is formed in the Hong Kong market. Hong Kong is akin to an offshore asset haven with high winds and rough waves, essentially having no capital movement barriers and being significantly influenced by international markets. The offshore RMB breaking the 7 barrier first indicates that international speculative capital is beginning to increase its entry into China.

3. The continuous appreciation of the RMB exchange rate is set against a larger backdrop: the United States has initiated a new round of interest rate cuts, and international hot money has started to flow out from the U.S., heading to various parts of the world. The destinations for international hot money are limited to places like Japan, India, China, and Vietnam. Official data confirm that foreign investors have been increasing their holdings of China's interbank market bonds for 12 consecutive months, with the total increase amounting to 1.34 trillion yuan in this cycle.

4. Another context for the RMB's appreciation is that China's foreign trade continues to advance strongly this year. In the first eight months, China's trade surplus reached a high of 608.49 billion U.S. dollars, a year-on-year increase of 11.2%. Although some money has "slipped away," the substantial trade surplus still allows the exchange rate to maintain strength and stability. As for China's foreign exchange reserves, they lead the world, exceeding 3 trillion U.S. dollars, accounting for nearly 30% of the total global reserves.

5. Behind the strong RMB exchange rate, there is an expectation: the magnitude of interest rate cuts in this round of the U.S. cycle will exceed that of China. Currently, the anchor of U.S. interest rates—the yield on 10-year Treasury bonds—is at 3.738%, while China's is at 2.088%, with the U.S. rate significantly higher than China's. It would be more reasonable for the future U.S. interest rates to be slightly lower than China's.

6. China's proposal to "counter involutionary vicious competition" is another important reason for the RMB's appreciation. Why counter involution? It is to alleviate trade conflicts with Western developed countries. Chinese products are too competitive; even if the U.S. imposes a 100% tariff on Chinese electric vehicles, they still maintain significant competitiveness in the U.S. market. A moderately strong RMB, controlling trade imbalances, can ease international tensions and is beneficial for long-term business. Therefore, China has recently proposed to counter involution, reducing government subsidies and tax and land concessions for certain industries, and even changing its investment attraction methods.Before and after the U.S. elections, it has always been a period when the Chinese yuan exchange rate is "strong + slightly appreciating," for the same reasons as mentioned above.

7. The current undervaluation of the Chinese yuan exchange rate is mainly due to the fact that after the pandemic, developed countries generally engaged in large-scale monetary easing, leading to a significant rise in prices. In contrast, China experienced a decrease in prices, which made Chinese manufacturing more competitive. Without the once-in-a-century major changes, the yuan exchange rate should have been around 6 yuan per U.S. dollar, or even 5.9.

8. What will happen to the yuan exchange rate in the future? The key lies in who becomes the driver of the United States.

If Trump returns and he truly imposes a 60% tariff on all Chinese goods, it is highly likely that the yuan exchange rate will return to around 7.3, or even 7.5. If Harris becomes the first female president, it is highly probable that the exchange rate will remain stable and strong.

Will the yuan appreciate and break through 6.8? Perhaps it can, but even if it does, it won't stay there for long.

9. The major counterattack of Chinese yuan assets has already begun. It was previously a bull market in bonds, and now it is a double bull market in both bonds and foreign exchange. Next, the stock market and the real estate market will follow suit. The stock market is relatively easier to warm up, while the real estate market is more complex and will show significant differentiation.

I maintain my previous judgment: If first-tier cities further relax real estate policies, coupled with significant fiscal policy efforts, the real estate market in the core areas of first-tier cities is expected to bottom out in the fourth quarter; the core areas of strong second-tier cities are expected to bottom out by the middle of next year; ordinary second-tier cities may have to wait until the end of next year or the following year.

However, note that this refers to core areas only. In the future, the real estate market in the same city will show a trend of "four seasons on one mountain, different weather every ten miles." As for ordinary third, fourth, and fifth-tier cities, if the population growth stops, there is no point in discussing their real estate markets; they may not increase for 10 to 20 years unless there is a super high inflation.

10. Is it necessary to exchange the previously exchanged U.S. dollars back into Chinese yuan?

I guess the U.S. dollars you exchanged before were mostly deposited in fixed deposits (with relatively high interest rates), so you might as well hold on to them for now. If they haven't been deposited in fixed deposits yet, it depends on your life planning and whether you have children preparing to study abroad. The next few months will be a good time to exchange U.S. dollars. Exchanging into U.S. dollars may mean losing short-term investment opportunities, but the risk is controllable. Stock trading and real estate investment still have uncertainties, and the profit cycle is also relatively long. From a short-term perspective (for example, within 6 months), the U.S. dollar is definitely not the best arbitrage asset.Today, the A-share market opened, and the Shanghai Composite Index surged by more than 60 points again!