Traders wait for the U.S. PCE inflation report

As of around 18:15 Beijing time on June 26th, the US dollar/CNH (offshore renminbi) broke through 7.3, with the renminbi hitting a new low since November last year. The renminbi has been weakening over the past two weeks, occurring against the backdrop of a resurgent strong US dollar in the past week, with Asian currencies under pressure. The Japanese yen broke through the 160 mark against the US dollar on the 26th, setting a historical low.

Wang Ju, Head of Currency and Interest Rate Strategy for Greater China at BNP Paribas, stated that although the central bank still intends to maintain exchange rate stability, the renminbi faces certain pressures in the third quarter due to the upcoming dividend season, tariff risks, and a significant China-US interest rate differential.

However, in the short term, traders are focusing on the upcoming PCE (Personal Consumption Expenditure) data to be released this week, which is also the Federal Reserve's preferred inflation indicator. If the PCE declines as expected, it will alleviate pressure on Asian currencies.

The renminbi faces seasonal pressures. Over the past week (June 17th-21st), the renminbi was generally weak, with a slight depreciation trend over five days. Especially starting last Thursday (20th), the offshore market saw a significant decline, leading to adjustments in the onshore market, with a weekly depreciation of 0.09%.

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This week, the weakness of Asian currencies continues, with the Japanese yen against the US dollar setting another historical low. Traders are awaiting the PCE data to be released on Friday. Wang Ju believes that there are several main reasons for the recent weakness of the renminbi—high-frequency indicators show that the momentum of industrial production improved unevenly in the first half of June; the actual economic credit demand in May remained weak, with almost all growth driven by the government sector; the central bank continues to gradually raise the exchange rate midpoint, recently breaking through 7.12. BNP Paribas believes that the central bank will continue to treat the depreciation of the renminbi in a moderate manner.

In terms of economic data, May's economic cycle indicators weakened compared to April, with May's social financing data continuing to "squeeze out the water," with a decline in M1 growth and weak private sector financing. In May, the social financing scale increased by 2.06 trillion yuan, reversing the previous negative growth trend, but mainly due to government bond issuance. In May, net government bond financing reached 1.2 trillion yuan, accounting for 59.2% of the May social financing increase. In terms of demand, the real estate market is still declining, consumption of durable goods such as automobiles is weak, and exports and manufacturing investment show resilience. Institutions believe that the core issues of the current domestic economy are weak private sector financing, weak domestic demand, and supply exceeding demand. The June PMI to be released this week is expected to be below the boom-or-bust line, and investors' attention to the upcoming Central Committee meeting in July and the Politburo meeting will increase, with the market focusing on reform trends, whether real estate policies will be intensified, and fiscal progress.

However, for the renminbi, there have been some positive signs since May. For example, the current account finally turned positive, exports have become a strong growth engine for China, and productivity continues to improve; the outflow pressure in the May FDI (Foreign Direct Investment) account has only slightly eased, mainly due to a slight decrease in ODI (Outward Direct Investment) compared to April. Nevertheless, ODI increased by 25% year-on-year in May, while FDI increased by 9%. Given China's goal of internationalizing the renminbi, institutions expect the trend of increasing ODI to be unlikely to fade in the short term; in May, net inflows of portfolio funds increased significantly, mainly from inflows of bond asset swap transactions.

Wang Ju stated that strong export inflows also help maintain currency stability. However, investors should be aware that the summer dividend season may lead to some capital outflow pressure. At the same time, the China-US interest rate differential remains high, which also leads some exporters to hold US dollars instead of converting them.

But institutions expect that the central bank's attitude towards maintaining the basic stability of the foreign exchange market will not undergo substantial changes. "There have been some changes in the People's Bank of China's operational model for maintaining foreign exchange market stability, such as transferring some onshore forward interventions to the offshore market, but we believe the central bank will continue to carry out some smoothing operations to control the pace of depreciation," she said.Short-term PCE data dominates the market

In the short term, due to a series of extreme events leading to the restrengthening of the US dollar, this also means that if any reversal occurs, the strength of the US dollar may be reversed.

StoneX senior strategist Scott (David Scutt) told reporters, "I don't believe the upward momentum of the US dollar index last Friday can continue. This trend was triggered by the unexpected strength of the S&P Global US Composite PMI, which contradicts the bearish signals of most other recent US economic data. PCE is likely to show that inflationary pressures have significantly eased compared to earlier this year, increasing the risk of rising expectations for the Fed to cut interest rates. Due to the uncertainty brought by the upcoming French election, the market sentiment towards the euro is also overly pessimistic, which has once boosted the strength of the US dollar." At 20:30 Beijing time on Friday, the PCE, the Fed's favorite inflation indicator, is about to be released. The market expects both the overall and core PCE to drop to 2.6%, compared to the previous values of 2.7% and 2.8%, respectively.

"The Fed has already raised its inflation forecast for this year and next year in its June economic outlook. If the data is higher than expected this time, it may strengthen the expectation of 'one interest rate cut for the whole year' and continue to benefit the US dollar. On the contrary, if inflation is lower than expected (such as the monthly rate falling below 0%), the US dollar may weaken, which is expected to help gold rebound. It is worth noting that the previous two data were higher than expected." Scott told reporters.

The Fed currently expects the annual interest rate cut forecast to be reduced to 1 time, while the market expects 2 cuts, with the market estimating a 61% chance of a 25 basis point cut in September, but there is still disagreement. Fed official Michelle Bowman said she believes there will be no interest rate cuts this year.

Due to political uncertainty and concerns about the economic prospects of the eurozone, the euro/dollar is under pressure, which has also driven the US dollar index up in recent times. "The French election will be held on June 30th, and concerns about political turmoil and spending plans are suppressing the euro. At the same time, the latest data shows that German economic business confidence has unexpectedly deteriorated, raising concerns about the loss of momentum in economic recovery." Scott said.

He believes that in the short term, the upward momentum of the US dollar index seems to be weakening. If the US dollar can further weaken, then the yen and the renminbi will be boosted. "Pay close attention to the US dollar/CNH, because it has not only led the strength of the US dollar/Japanese yen buying in recent times, but also has a strong correlation with the US dollar/Japanese yen in the past month. Although the trend of the US dollar/CNH during the same period is not strong, the US dollar/CNH has also had a strong negative correlation with the Australian dollar/US dollar and the New Zealand dollar/US dollar for most of the year."