Concurrent Depreciations of the RMB and the US Dollar: Insights and Implications
Author:NI Shuhui XIAO Lisheng
Since March 24，2023，the renminbi (RMB) has depreciated against the US dollar，recording a drop of 5.74% by June 30. Simultaneously，the volatility in the US dollar's strong momentum was marked by two periods of decline from March 24 to April 26 and from May 31 to June 21，both of which coincided with the RMB’s depreciation. Typically，there is a strong negative correlation between the exchange rate of the RMB against the US dollar and the US dollar index. The concurrent depreciations of the two currencies suggest that even if the US dollar index declines，the RMB may still face considerable downward pressure. Based on the recent trends，we have identified that simultaneous depreciations of the RMB and the US dollar tend to occur during periods of misalignment in currency cycle transitions. This scenario is typically characterized by three facts，i.e. shrinking economic fundamentals of both China and the US，deficits in China’s foreign exchange settlement and sales，and narrowing interest rate differential between the two countries. It is important to note that this scenario is usually addressed through an improvement in economic fundamentals rather than an increase in the interest rate differential. The concurrent depreciations of the RMB and the US dollar since 2023 bears a resemblance to the situation observed in 2016. In future，the trajectory of the RMB will be influenced by changes in the US dollar index. Crucially，the principal determinant will be the recovery of China’s economic fundamentals. And the RMB is expected to rebound in the second half of 2023.
Review of Concurrent Depreciations of the RMB and the US Dollar
Through the recent trend of RMB depreciation，the two consecutive episodes of US dollar devaluation were relatively rare occurrences. It is thus essential to conduct a systematic review of the conditions under which the RMB and the US dollar simultaneously depreciated to identify how this scenario arose and how it was resolved. By examining the similarities and differences between the depreciating momentums of the two currencies，we can gain valuable insights into the future trajectory of the RMB.
Analysis of historical trends reveals that only five concurrent depreciations of the RMB and the US dollar have occurred from the exchange rate reform initiated on August 11，2015 to the end of 2022. Any of the simultaneous depreciations of the RMB and the US dollar represented a rare occurrence featuring short episodes with long intervals between them. A survey of the five simultaneous depreciations indicates that the intervals between them tended to be relatively long，generally ranging from 7 months to 28 months. Whereas these episodes of depreciation were rather short，with the longest one lasting 39 days and the shortest one 26 days. Throughout most of these cases，the exchange rate of the RMB and the US dollar index maintained a strong negative correlation. However，it is crucial to emphasize that the two consecutive periods of simultaneous depreciation in 2023，despite their relatively brief durations，are of particular significance. This is mainly because they occurred within an exceptionally narrow span of just one month. As such，it merits a more thorough investigation. Moreover，simultaneous devaluations of the RMB and the US dollar tend to occur during periods of misalignment in currency cycle transitions. From this perspective，we can see a clear pattern in the five simultaneous depreciation episodes. Three of them occurred in the early stage of a US dollar depreciation cycle and also the late stage of a RMB depreciation cycle. Another two occurred in the early stage of a US dollar appreciation cycle and the late stage of a RMB depreciation cycle respectively. These findings suggest that stronger market uncertainties during misalignment periods of currency cycle transitions tend to cause a divergence from the customary negative correlation between the two currencies. Therefore，successive episodes of simultaneous depreciation of the RMB and the US dollar in 2023 are likely to reflect misalignment in the currency cycle transitions of the two currencies.
Three Key Characteristics of Concurrent Depreciations of the RMB and the US Dollar
By analyzing the key indicators that influence the exchange rates of the RMB and the US dollar during periods of concurrent depreciation，we have identified three significant characteristics which might be important contributing factors of these occurrences. First，the simultaneous depreciations of the RMB and the US dollar typically occurred during periods when there were downturns in the economies of both China and the US. Among the five cases，four of which took place during periods of economic contraction. This implies that the simultaneous shrinking or deterioration of economic fundamentals contributed significantly to market uncertainties. Secondly，China often recorded a deficit in its foreign exchange settlement and sales or a reduction in foreign exchange settlement during the episodes of simultaneous depreciation of the RMB and the US dollar. Among the five cases，four coincided with periods of deficits in foreign exchange settlement and sales，while one occurred during a period when the foreign exchange settlement and sales surplus narrowed. Thirdly，simultaneous depreciations of the RMB and the US dollar mostly occurred during periods of a narrowing interest rate differential between China and the US. The interest rate differential can be calculated by subtracting the yield of 10-year US government bonds from that of 10-year Chinese government bonds. Among the five historical cases，four occurred during periods where the interest rate differential narrowed. In terms of economic fundamentals，the Purchasing Managers’ Index (PMI) for the manufacturing sector in the US was 47.1 and 46.9 in April and May 2023，respectively. Meanwhile，China’s manufacturing PMI in the corresponding periods was 49.2 and 48.8，respectively. These numbers indicated that both the US and Chinese economies were experiencing a downturn. In March 2023，China recorded a deficit of 109.73 billion yuan in foreign exchange settlement and sales by banks. This transformed into a small surplus in April，but the surplus narrowed in May. Moreover，the interest rate differential between the two countries decreased from -0.5124 to a record low of -0.7442 between March 24 and April 26. Subsequently，from May 31 to June 21，the differential further declined from -0.9550 to its lowest point of -1.2173.
Simultaneous Depreciations of the RMB and the US Dollar Mostly Terminated by Upturn of Economic Fundamentals
Changes in the three indices upon the conclusions of the five simultaneous depreciation episodes of the RMB and the US dollar indicate that the termination of such situations depended primarily on the improvement of economic fundamentals. In contrast，the interest rate differential did not play an important role in the process. Based on the economic fundamental indicators，it can be seen that during periods of simultaneous depreciation of the RMB and the US dollar，there were three instances when the manufacturing PMI in both China and the US hit a low point before a rebound. Furthermore，o