In all the drama surrounding the French elections, few noticed the PBOC's announcement that China’s FX reserves rose for the third straight month in April, increasing by $20.45 billion to $3.03 trillion, more than the $11 billion expected and the single biggest monthly increase in three years going back to April 2014, on the back of a weaker dollar and increasingly more draconian capital controls on outflows.

Cited by the WSJ, some economists attributed April’s increase to a dollar that continued to decline in the past month especially after Trump said the U.S. currency “is getting too strong.” The value of other currencies in China’s reserve basket, including the euro, the British pound and Japan’s yen, similarly played a significant role in the rise, said Yan Ling, an economist with China Merchants Securities.

Besides USD softness (USD has weakened against the CFETS basket by over 2% year-to-date through April) and perhaps stronger RMB sentiment, the capital flow management measures introduced over the last several months have also contributed to the slowdown in outflows, Goldman speculated in a Sunday note. That could reverse, as there may be incremental relaxation of the capital account as the flow situation has improved and an overly tight capital account could hinder legitimate international trade and the authorities' long-term RMB internationalization goals.

“Downward pressure on the currency has significantly subsided thanks to capital controls introduced in late 2016 and early 2017,” Dariusz Kowalczyk, a Credit Agricole economist, told Bloomberg. “This means that going forward, depreciation will be very gradual.”

However, any systematic roll-back of capital controls is unlikely in the near term, given it is still uncertain as to whether and how fast outflows could pick up again in case the USD re-strengthens significantly, Goldman adds. Furthermore, some degree of capital account restrictions could beneficially help reduce volatility during the process of exchange rate liberalization. “The Chinese central bank no longer cares that much about the level of exchange rate. Rather, they now care more about the basic stability of the foreign-exchange reserve,” said Zhou Hao, an economist with Commerzbank AG .

Or perhaps it's none of the above, because in a separate analysis Goldman calculates that after adjusting for currency valuation effects, reported reserves remained unchanged.

"We estimate currency valuation effects at about +US$19bn, given the notable appreciation of GBP and EUR against the USD during April. Excluding such estimated effects, reported FX reserves would have increased marginally by US$1bn (vs. a decrease of around US$4bn in Mar)", Goldman's MK Tang wrote in a report over the weekend. Other confirmed: “In addition to valuation effects, stronger trade data as well as dented capital outflows should be responsible for this slight rise,” said Frederik Kunze, chief China economist at German lender NordLB in Hanover.

“April’s reserve increase reflects a combination of valuation effects, tighter capital controls and a more stable yuan,” Tom Orlik, chief Asia economist at Bloomberg Intelligence in Beijing, wrote in a note. “At the start of the year, there were genuine concerns China faced another flood of capital outflows. That clearly hasn’t happened.”

As usual, subsequent data on the PBOC's FX position and SAFE flow data will be key in determining the true direction and size of China's latest FX flow situation. These can be expected as follows: SAFE data on FX settlement onshore and cross-border RMB flow: May 17; PBOC FX position (spot; net of valuation effects): around mid-May; PBOC reported forward position: end-May.

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And while it is still early to speculate whether China's capital outflows have ended, Horseman's Russell Clark has done just that and in a recent report wonders if we have seen "The End Of The Chinese Yuan Bear Market." Some excerpts from his recent note below:

The Chinese Yuan (CNY) was fixed for many years before beginning to appreciate in 2005. Since 2014 it has been in a weakening bias, as the US dollar has been relatively strong. Part of the weakness in the CNY was due to China cutting interest rates from 2015 to help prop up growth. This greatly reduced the relative spread between interest rates between China and the US and put pressure on the currency. (Shanghai Interbank Offer Rate (“Shibor”), London Interbank Offer Rate (“Libor”)). 

As can be seen the divergence between interest rates is now beginning to move in CNY’s favour.

As rates were cut and the CNY weakened, there was a large outflow from both foreigners and locals. One example is the movement out of CNY by Koreans. This collapse in foreign exposure to China is confirmed by Bank of International Settlements (“BIS”), although this data is only to q3 2016.

What I find interesting is that the currencies of countries with strong trade links to China, namely Taiwan and Singapore, were good early signals to an imminent Chinese devaluation in 2014. These currencies, and particularly the Taiwanese dollar have strengthened considerably recently.

Intriguingly the interest rate needed for offshore CNY deposits in Hong Kong has fallen below the mainland rate for the first time since 2015.

 

As can be seen, Hong Kong deposit rates can fall below the mainland rate depending on the locals’ view of the CNY exchange rate. Given the reduced positioning of foreigners in CNY, the flattening of the banks’ foreign currency positions in Chinese banks, the strengthening of CNY proxy currencies and the implied bullishness of Hong Kong depositors on the CNY, the CNY looks more likely to appreciate than depreciate from here.