Chinese FX reserves fall to six-year low

Chinese currency reserves fell below USD3trn in January for the first time since February 2011. FX reserves fell USD12.3bn to USD2998.2bn from USD3010.5bn in December. However, correcting for currency moves (for example, EUR strengthened in January, versus USD lifting the value of euro reserves), we estimate that the adjusted decline was around USD36bn. This is a similar pace of decline as in December and shows that China continues to struggle with capital outflows. If the decline continues at this pace, China will lose around USD500bn of reserves per year.

While the decline is not as big as in early 2016, it is still a concern that money keeps flowing out of China. This is part of the reason why the People's Bank of China pushed up offshore money market rates in December and January, to make it more expensive to short the CNH, the Chinese offshore currency. In this way, it aims to stop depreciation of the CNY and is trying to dampen outflows based on fears of devaluation. Offshore money market rates with longer maturities (3M and 12M) are still much higher than normal – most likely in an attempt to continue to deter selling of the offshore currency CNH.

However, we expect outflows to continue as the Chinese economy is under significant structural pressure from too much debt and too many investments. Although China is taking measures to dampen outflows by tightening controls, we believe a gradual outflow is still likely. In addition, with the Fed raising rates and Chinese growth about to slow, the pressure will be for further weakness of CNY versus USD. We look for the weakening trend of CNY to continue.

AG Markets Review