What is the Path of Least Resistance for the RMB?

As we have and will continue to discuss on this blog, the level of the RMB has been a major driver of market moves ever since it began its depreciation trajectory at the beginning of 2014. We will further make the case as to why the level of the RMB vs the USD is such an important variable the coming days, but for now we’ll focus on the likely near-term direction.

One hugely important indicator of the likely path of the RMB vs the USD is the spread between the offshore yuan rate and the onshore rate. Theoretically, the offshore rate should be somewhat less impacted by currency intervention than the onshore rate, though obviously some arbitrate opportunity would limit any discount or premium. In general, when the offshore rate is trading at a discount to the onshore rate (read a positive spread), the RMB tends to be flat or depreciating to against the USD, and the reverse is also true. Additionally, the wider the spread the more impetus for a move in one way or the other.

Currently the spread is slightly positive (meaning the offshore rate is trading at a discount to the onshore rate), though the spread has come down as the yuan has moved from 6.7 to 6.67 (chart 1). In chart 2 we highlight in black all the periods when the spread is positive. From this it’s clear that the RMB does not strengthen against the USD with a positive offshore-onshore spread. More likely, a positive spread results in a weaker RMB.