CNY (7.227)

• The yuan traded nearly flat before ending the month stronger at 7.23 against the greenback, as the USD index weakened by nearly 2.0% in July. China's weaker-than-expected 2Q24 GDP growth prompted the People's Bank of China (PBoC) to implement surprise cuts to its loan prime rate and medium-term lending facility rate. Although the yuan initially weakened after the cuts, it later stabilised, possibly as the market saw these measures as efforts to revive sluggish economic growth.

• In the short term, rate cuts may pressure the yuan to depreciate due to the widening of China-US yield differential. However, the soft USD narrative could help the yuan stabilise around its current level. The PBoC is expected to hold rates steady this month, with further cuts possible if needed, especially if the US begins its anticipated rate cut cycle in September. Yield spreads would gradually move to favour a stronger yuan, as the Fed is likely to cut more aggressively than the PBoC.

JPY (150.510) ▲

• The yen appreciated against the USD, ending July at its strongest level since March. Initially broad USD weakness due to US disinflationary trend and falling Treasury yields supported the yen. However, the primary driver was the Bank of Japan's (BoJ) unexpected 15 bps rate hike. The market had not anticipated this move, and Governor Ueda's hawkish remarks— further boosted the yen, leading to nearly 3.0% gain postdecision.

• The BoJ-Fed monetary policy divergence may continue to support the yen's appreciation against the USD. Higher wage growth and improving consumption strengthen the case for BoJ's policy normalisation, possibly leading to another rate hike in 4Q24. With expected Fed rate cuts due to a weakening US economy, this scenario favours the yen. However, this outlook is contingent on Japan's economic condition, which remains relatively weak. Additionally, elevated geopolitical tensions could favour the USD instead.

Source: Kenanga Research - 2 Aug 2024