RMB Index: Has the Upward Trend Come to a Halt?

Morning FX

At the end of January, the RMB Index experienced its first significant pullback in this round of the upward trend.The index, composed of factors such as the US dollar, euro, Korean won, Japanese yen, and Australian dollar, measures the strength of the RMB relative to a basket of currencies, dropping from a peak close to 99 to 97.50 within a week.

Chart: RMB Index Pullback

Visually, the euro against the RMB rose from 8.07 by 2000 pips to 8.26; the Japanese yen against the RMB rebounded from historical lows by 1000 pips to above the support level of 4.50.

I. Why was the trend of RMB's outperformance broken?

This round of the RMB Index's upward trend began in July last year. Amid the sideways movement of other non-USD currencies, a record trade surplus drove the independent appreciation of the RMB.

Yet, in this round of collective de-dollarization, the RMB did not keep pace. Euro-led European currencies rose rapidly, driven by safe-haven capital. The yen, under the threat of intervention, saw USDJPY plunge by 500 pips in a single day. In contrast, although the RMB's central parity rate dipped towards 7.0, there was no panic, and USDCNY never fell below 6.95.

Chart: Non-USD currencies surge against RMB

Behind this is a divergence in currency logic: the RMB is driven by internal factors, with appreciation guided in an orderly manner by the supply and demand of foreign exchange settlement. This is also reflected in the simultaneous increase in volatility among non-USD currencies while RMB volatility remains low. In contrast, non-USD currencies are stimulated by external factors, as panic from US credit issues and fear of intervention trigger capital repatriation and speculative unwinding.

Chart: RMB volatility remains calm

II. What is the outlook for the RMB?

Comparing this to the first round of de-dollarization that began last April, at that time EUR/USD, after parity tariffs, climbed continuously from 1.08 to above 1.18 in five months, an appreciation of nearly 10%, while the RMB only appreciated about 2% during the same period.

If this round is similar in magnitude to last year, the current pullback in the RMB Index is not yet over. Objectively speaking, however, the intensity and sustainability of Europe's reaction this time are questionable, so the euro's rise may not match last year's, and therefore the RMB Index's pullback will also be limited.

Chart: RMB volatility remains calm

From another perspective, there is still upward momentum for the RMB against the USD. After USDCNY broke below 7.0 in December, the overall downward trend has been established. This round of appreciation led by non-USD currencies has provided further momentum for the RMB.

III. Summary

(1) The RMB Index saw a significant pullback at the end of January, due to its absence in this round of de-dollarization, showing that the supply and demand for RMB exchange rates is still driven by internal factors.

(2) Looking ahead, the rally in non-USD currencies in this round provides momentum for further RMB appreciation, and settling foreign exchange at high points remains a prudent choice.