Yuan strengthens as Chinese stocks continue robust rally

Global investors are continually buying into the rally in China's equity market, which has taken the renminbi to its highest level in several months and reinforced hopes that the country's earlier economic recovery would sustain the bullish market sentiment, analysts said.

Chinese stocks extended their rally on Tuesday, with the CSI 300 index of shares listed in Shanghai and Shenzhen gaining 2 percent in early trading, although the rise slowed to 0.6 percent at the close. On Monday, the index surged 5.67 percent, its biggest daily gain in five years.

The People's Bank of China, the central bank, set the central parity of the RMB exchange rate against the US dollar, or the daily trading reference, at 7.0310 on Tuesday, up 353 points from Monday, the largest daily appreciation since April 9. The offshore yuan strengthened past 7 per dollar for the first time since March.

The huge influx of "northbound capital", which flowed from overseas to the mainland through stock connect programs linking onshore and offshore capital markets, indicated that global investors are buying Chinese stocks. The rally resulted in large demand for the renminbi and strengthened its value, Guan Tao, chief global economist at BOC International (China) Co Ltd, told China Daily.

According to Wind Info, a Chinese financial data platform, net inflows of northbound capital totaled 53.8 billion yuan ($7.66 billion) in the four consecutive trading days ending on Tuesday.

"Basically, the booming stocks and currency are supported by an optimistic outlook for China's economic fundamentals, as domestic COVID-19 infections have largely been brought under control and the latest purchasing managers index showed a strong rebound," said Guan, who is also a former senior official with the State Administration of Foreign Exchange, the nation's foreign exchange regulator.

To offset the economic impact of COVID-19, central banks around the world have flooded financial markets with ample liquidity, which has boosted asset prices, especially in the equity market, according to analysts.

Different from the capital market rally five years ago, institutional investors hold more prudent portfolios nowadays, but they still need to prevent unexpected volatility if asset prices surge too quickly or if a second wave of the pandemic arrives, Guan added.

Recent volatility in the global financial markets, such as the falling dollar index, has led to changes in China's foreign exchange reserves, which increased to $3.11 trillion at the end of June, up $10.6 billion or 0.3 percent from a month earlier, hitting their highest level since February, the SAFE announced on Tuesday.

Affected by the COVID-19 pandemic and the monetary and fiscal stimulus policies in major economies, the US dollar index has fallen slightly while asset prices in major countries have risen, which were the factors that led to the increase in China's foreign exchange reserves in June, according to Wang Chunying, a spokeswoman for the SAFE.

"The current overseas situation of the pandemic and the world economy remains grim and complex, with increasing fluctuations in global financial markets. China has made significant achievements in prevention and control of the disease, while accelerating the resumption of production. Various economic indicators have improved marginally, and the economy is gradually recovering," Wang said.

The world's second-largest economy has remained attractive for investors despite the impact of the pandemic, and China has seen all fund types register net inflows in the first five months of this year, according to research released on Tuesday by Fitch Ratings, one of the world's three biggest rating agencies.

Total open-end mutual fund assets in China, for example, swelled by 20 percent in the January-to-May period from a year earlier to 15.8 trillion yuan, driven by institutional and retail demand, supported by a faster economic recovery and recent substantial growth in money supply, Fitch said.

Globally, "sentiment remains bullish despite the many questions around economic prospects over the medium and long term. We may have seen a positive rebound in several releases of economic data over the past couple of weeks," said Hussein Sayed, chief market strategist at FXTM, a global foreign exchange trading platform.

"There are factors contributing to the rally," Sayed said. "With an unprecedented amount of cash in the system, equities and high-yield bonds are attracting a lot of interest from investors in the absence of acceptable yields from money markets and longer-term government bonds."

"That may continue to push risky assets higher, although valuations are approaching extreme levels," Sayed added. "To keep this rally alive, we need more intervention from fiscal and monetary policymakers and for investors to believe that policies will be generous enough to provide further liquidity."