China leads global FX volatility

20 January,, London – Does China leads global FX volatility? The recent depreciation of the RMB and volatility in Chinese financial markets have been associated with spillovers to global financial and commodity markets.

According to Citi, the depreciation of the RMB reflects large capital outflows, due to fundamental challenges to the economy and politics, and ongoing reforms in the Chinese policy regime towards FX flexibility, which Citi believes is compounding general policy uncertainty.

“We now expect RMB to depreciate faster than we thought previously and forecast USDCNY at 7.20 in 12M, which, given a stronger USD vs other currencies, would imply around 5% depreciation of the RMB vs the CFETS RMB basket,” Citi projected.

The downward process is unlikely to be smooth, as the last few trading days already revealed periodic efforts at intervention and some tightening of capital outflow measures.

China leads global FX volatility

China leads global FX volatility

The weakness and risks around the RMB and Chinese economic growth are disinflationary and are weakening demand growth in the rest of the world. Financial market spillovers and worries about policy ineffectiveness elsewhere could elevate the global ramifications of Chinese shocks. China-driven FX volatility is likely to be present in 2016 as it was during 2015.

“The Chinese developments are also part of a bigger picture in that more countries and central banks are willing to use exchange rate weakness (and, to a lesser extent, exchange rate flexibility more generally) as a shock absorber or a tool to achieve other policy objectives,” Citi added.

Qualitatively, such developments increase the probability of a further easing and reduce the odds of tightening for developed market’s central banks. Yet, the latest Chinese developments have not led Citi to change its major monetary policy forecasts yet.

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