China's Trade Balance and the Potential for FX Sales
China's trade balance hit $852bn in the year leading up to July, reflecting weak domestic demand and Chinese manufacturers gaining a larger share of the global market. However, what is less discussed is the activities of Chinese goods traders who have recently reduced FX sales from this surplus. This situation could change rapidly in the upcoming quarters as the US policy cycle shifts.
Impact of Dollar Weakness on Exporter FX Sales
The size of China's goods balance is often discussed, but the recycling of this foreign exchange surplus is less frequently examined. The conversion of this FX surplus could be crucial for the Chinese exchange rate, the CNY, in the upcoming months. Goods traders have been hesitant to convert their net export proceeds (mostly FX) into renminbi in recent months. This is due to the fact that interest rates on FX deposits are currently higher than renminbi equivalent, and as RMB sentiment remains weak. However, with the Fed considering initiating rate cuts for the first time this cycle, the interest rate differential could swing back in favor of Chinese assets, altering the conversion calculus for exporters.
Historical Dollar Weakness and Goods Exporter Behaviour
To consider prospects over the next year, we can examine goods exporter behaviour during past episodes of dollar weakness. The US Dollar is extremely elevated when measured using the Fed's broad NEER, standing at the 91st percentile (vs. the 2015-2024 history). However, it has started to decline, and given the prospect of an aggressive cutting cycle by the Fed, could decline more persistently.
There are four recent episodes when the Dollar peaked: Jan. 2016, Jan. 2017, May 2020, and Nov. 2022. During periods of dollar weakness, FX conversion rates bottom out right around the time when the Dollar starts to decline.
FX Conversion Rate Changes and Implications
If we look at how much the FX conversion rate changes compared to the month prior to dollar peaks, all four episodes saw a large increase in the FX conversion rate. The median episode peaks out at +56%-pts nine months after the Dollar has peaked. This 56ppt increase would still leave the FX conversion rate at a relatively normal peak level of 63% (80th percentile). This is due to the fact that FX sales by Chinese goods traders have been very low this cycle and stood at just 6% of the trade balance in July and only 9% across Q2, much lower than the 2016-2024 average of 43%.
However, even this 56ppts increase in conversion would have important implications. FX sales could increase $15-22bn/month compared to the pace over the past 3-12 months using Bloomberg consensus forecasts of export and imports. This implied path sees goods traders' FX sales increase from just $4bn in July to $53bn by May next year.
Could This Time Be Different?
Even if the Dollar declines substantially, the impact on goods traders' FX sales this time around could be more muted than has historically been the case. Chinese authorities might push back against aggressive renminbi purchases by goods traders. Authorities might prefer that exporters convert their Dollars into other FX assets and gold rather than into renminbi. This would lead to indirect downwards pressure on USDCNY through sales of Dollars and purchases of other currencies.
Another factor is that exporters' downbeat sentiment on the renminbi could possibly be sticky as the slowdown in Chinese growth is likely viewed as more structural than during prior growth declines. US yields could well remain above that in China in the coming quarters, making exporters prefer to park excess cash in FX rather than RMB.
Bottom Line
Fed normalisation could allow a large pickup in dollar sales by Chinese goods traders, potentially up to $15-22bn per month in the coming quarters. However, even if Dollar weakness materializes, multiple factors could lead to a smaller-than-usual increase in FX sales. What are your thoughts on this potential shift in FX sales? Share this article with your friends and sign up for the Daily Briefing, delivered every day at 6pm.
