Core Views 1. What is the popular narrative and its core logic? Fed rate cuts → RMB appreciation → potential damage to export competitiveness. 2. Where are the weaknesses in this narrative logic? 1) Fed rate cuts do not necessarily equate to a sustained weakening of the US dollar; 2) RMB appreciation does not necessarily equate to damaged export competitiveness. 3. How to view the future trajectory of the RMB exchange rate? We believe the RMB exchange rate is currently neutrally valued, with no significant over- or under-valuation. Internally, supported by resilient exports and policy support, the RMB has a stable foundation. However, the fundamental momentum for a sustained, substantial rebound may still require further accumulation. Concurrently, the shadow of the counter-cyclical factor has recently been consistently moderating appreciation volatility. Externally, the Fed's potential pre-emptive rate cuts might help support US economic growth and the relative advantage of its asset prices. Coupled with the fact that short positions on the US dollar index are already quite extreme, the pressure for a sustained, one-sided weakening of the dollar may be limited. Therefore, the probability of a trend of significant RMB appreciation against the US dollar is not high. Nevertheless, the RMB appreciation since May may have already prompted the release of some pent-up corporate foreign exchange settlement positions, potentially widening the tolerable fluctuation band for the RMB. It is also crucial to note that the release of remaining pent-up foreign exchange positions around the key psychological level of 7.0 could amplify appreciation volatility. In the long run, only substantial appreciation underpinned by strong economic fundamentals is sustainable, manageable, and desirable. While the exchange rate might often appear as a usable tool or a cause in the short term, in the long term, it should be the outcome of economic performance, difficult to manipulate forcefully, and tends to be a lagging, rather than leading, indicator of fundamentals. The future of the RMB exchange rate depends on many complex factors. However, maintaining stable fluctuations (with limited appreciation幅度) currently appears to be the optimal choice.

Report Summary I. The Popular Narrative on Exchange Rates: Fed Rate Cuts → RMB Appreciation → Potential Damage to Export Competitiveness? Recent discussions about RMB appreciation have intensified, focusing on a core narrative chain: Fed rate cuts → US dollar weakness → RMB appreciation → potential harm to China's export competitiveness.

II. How Solid is the Narrative Logic? One Stable, Two Unstable (A) Fed Rate Cuts → Sustained US Dollar Weakness? – Unstable Historically, the correlation between the US dollar index and the Fed's policy rate has been unstable. Periods where the federal funds target rate decreased while the US dollar index rose are not uncommon. The monthly correlation coefficient between Fed policy rate adjustments and monthly changes in the US dollar index since October 1982 is only 0.04. (B) Narrowing China-US Interest Rate Differential → Sustained RMB Appreciation? – Relatively Stable Since 2022, the co-movement between the interest rate differential and the RMB exchange rate has significantly strengthened. The monthly correlation coefficient between the US-China interest rate differential and the spot exchange rate from January 2022 to the present is as high as 0.88. (C) RMB Appreciation → Damaged Export Competitiveness? – Unstable Examining three measures of the RMB exchange rate—bilateral rate (USD/CNY spot), nominal effective exchange rate, and real effective exchange rate—against export growth (as a proxy for competitiveness) reveals that only the real exchange rate might suggest a link between appreciation and weakened competitiveness. For nominal rates, neither the basket nor the bilateral rate supports the argument that appreciation harms competitiveness. However, the current market discussion on RMB appreciation primarily refers to the bilateral rate against the USD. International experience also shows little correlation between export market share (measuring relative competitiveness) and nominal or real effective exchange rates for major economies, further undermining the argument.

III. A Two-Stage Attribution for This Year's RMB Appreciation Decomposing the drivers of RMB movements based on the central parity pricing formula reveals two distinct phases in the appreciation since Q2: The first stage, from mid-April to November, was primarily policy-driven. The shadow of the counter-cyclical factor was the dominant force behind the central parity's appreciation, with the spot rate consistently weaker than the central parity, indicating the central parity was "pulling" the spot rate stronger. The second stage, from late November to present, is market-driven. Domestic supply and demand (primarily corporate FX settlement) became the main driver, supplemented by external factors (a weaker USD index). The counter-cyclical factor shadow shifted to moderating rapid appreciation. The spot rate turned stronger than the central parity, meaning the spot rate was "pulling" the central parity stronger.

IV. Outlook for the RMB Exchange Rate Based on the analysis above, the outlook hinges on four factors: (A) Valuation: Is the exchange rate overvalued or undervalued? From both the interest rate differential/single currency perspective and the export competitiveness/basket perspective, the RMB does not appear significantly misaligned. Deviations from the estimated "value anchor" are around 0%-2%, within a reasonable range. (B) Policy Stance: How will the counter-cyclical factor shadow move? The policy stance has shifted from guiding gradual appreciation to curbing excessive appreciation volatility, suggesting an intent to maintain stability rather than fostering expectations of a one-sided trend. (C) Domestic Supply/Demand: Flow Logic vs. Stock Logic Flow logic suggests sustained trend appreciation requires improvement in the balance of payments, driven by exports and, crucially, a trend improvement in the PMI boosting the net FX settlement ratio. Currently, exports show resilience, but the manufacturing PMI lacks a clear upward trend. Stock logic highlights the risk that the release of a large backlog of accumulated FX receipts (estimated at a significant scale from strong exports in recent years but low settlement ratios) could amplify appreciation volatility, especially as the spot rate approaches key levels like 7.0. (D) External Response: Where is the US dollar headed? The Fed's potential "pre-emptive" rate cuts might support the US economy. Historical analysis suggests that when Fed rate cuts are not followed by recession, the USD tends to strengthen initially before stabilizing, rather than weakening persistently. Combined with extremely bearish positioning in USD futures, the probability of sustained, one-sided USD weakness appears low.

In summary, the RMB is fairly valued. Internally, stability is supported, but strong trend appreciation awaits clearer fundamental momentum (like a rising PMI). Externally, USD weakness may not be persistent. Thus, significant trend-based RMB appreciation against the USD seems unlikely. However, volatility could be amplified by the release of pent-up FX positions near the 7.0 level.

Risk warnings: Fed monetary easing exceeds expectations; US dollar index weakens beyond expectations; changes in the Russia-Ukraine conflict exceed expectations; domestic price recovery exceeds expectations; potential errors in the counter-cyclical factor shadow estimation model.