After the RMB breaks 7

Core Viewpoint

Yesterday (December 25), the offshore RMB to USD exchange rate broke through the important threshold of 7.00 during trading, and the onshore RMB also surpassed 7.01. We previously indicated that "the RMB breaking 7 is imminent" (December 4). Now that we have crossed the symbolic level of 7, we remain optimistic about the potential and momentum for RMB appreciation. On the fundamental level, the RMB exchange rate is highly competitive, and its relative price advantage is increasing day by day—an annual appreciation of 4-5 percentage points does not affect the overall advantages of China's export industry. Beyond the peak of foreign exchange settlement as a catalyst, we are also paying attention to the potential benefits of the "New Year Red" in 2026 and the further easing of China-U.S. economic and trade relations. In terms of market environment impact, the current appreciation of the RMB (correcting undervaluation) is expected to enhance foreign investment's attention to RMB assets and risk appetite, forming a "positive cycle" with capital inflows, boosting asset valuations and interbank liquidity, which in turn is conducive to easing financial conditions. We reaffirm our prediction of an exchange rate of 6.82 for USD to RMB by the end of 2026, and a nominal GDP growth of 8.5-9% for China in USD terms in 2026.

1. Multiple Factors Drive RMB Exchange Rate to Break 7 Again After Two and a Half Years

The last significant appreciation cycle of the RMB occurred from November 2022 to mid-January 2023, where the post-pandemic economic restart "pulse" drove the RMB to USD exchange rate from 7.3 to 6.71 (an appreciation of 8.8%), but this was mainly event-driven and lasted for a short time. In the subsequent two years (until early 2025), although the RMB experienced brief periods of appreciation, it was mainly driven by short-term market trading behavior and positioning (such as the reversal of arbitrage trades in the summer of 2024), with limited magnitude and sustainability (Chart 1).

It was not until after May 2025 that the RMB began to enter a more sustained appreciation trend, and this trend reversal underwent a repeated process of "bottoming out," accumulation, moderate appreciation, and accelerated appreciation (Chart 2), ultimately leading to a more sustained and "certain" appreciation trend, which we have continuously tracked in a series of previous reports.

Recently, the consensus on RMB appreciation has gradually established, and the speed of appreciation has accelerated, benefiting from some cyclical factors "catalyzing" it, with short-term prospects for continuation.

• On one hand, after the Federal Reserve's rate cut, the short-term interest rate differential between the U.S. and China has narrowed, and with the upcoming announcement of the new Federal Reserve chair, the market is beginning to anticipate the prospect of rate cuts next year, all of which support the recovery of low-interest-rate economies' exchange rates.

• At the same time, judging from the seasonal patterns of liquidity, foreign exchange settlement before the Spring Festival may drive the RMB to appreciate more rapidly.

• Looking slightly longer term, after May, the situation of China-U.S. trade negotiations has "tested" a more "stable" boundary amidst fluctuations, and overall, the trajectory of China's economy and price indicators has surpassed the more pessimistic expectations at the beginning of the year, which has also somewhat weakened the logic of shorting the RMB previously.

2. A Series of Recent "Catalysts" Accelerate RMB Revaluation On the fundamental level, the RMB exchange rate has strong competitiveness, and its relative price advantage is increasing day by day. At the same time, the "mismatch" of domestic and foreign assets only needs to "regress" from the extreme preference for overseas assets, without needing to "reverse," to create significant momentum for the continued appreciation of the RMB.

From April 2022 to June this year, the real effective exchange rate of the RMB has cumulatively adjusted by 19%, marking the largest adjustment cycle since 1990. Meanwhile, the cost advantage of Chinese enterprises has continued to widen compared to overseas in recent years. In recent years, the absolute value and global share of China's manufacturing, exports, and trade surplus have been steadily rising. From the perspective of purchasing power parity, multiple comparable tradable price indicators point to an undervaluation of the RMB exchange rate (Chart 5). Since 2020, the cumulative increase in China's PPI in USD terms has been 39 percentage points lower than that of the United States and 49 percentage points lower than that of Europe. It is estimated that in 2025, China's GDP deflator will increase about 2.5-3 percentage points lower than that of the United States, and the PPI increase will be 4.5-5 percentage points lower than that of the United States (Charts 6 and 7) — in other words, dynamically speaking, an annual appreciation of 4-5 percentage points would not harm the overall advantage of China's export industry.

At the same time, we reiterate that Chinese enterprises and financial institutions have a long-term preference for allocating overseas assets, and with the RMB exchange rate risk-adjusted expectations becoming more "neutral," there is enormous potential for cross-border capital inflow. As the global reserve currency, the US dollar enjoys a high valuation premium and excess allocation in the era of accelerated globalization. Since 1990, China's trade surplus with the US has exceeded USD 7 trillion, resulting in a large-scale accumulation of overseas assets. After 2015, the proportion of export settlement in China has significantly decreased, leading to a substantial excess "allocation" of dollar assets by Chinese exporters. Even based on the 55% settlement ratio at the end of 2021, exporters have had over USD 600 billion in export income unconverted since 2022, indicating further room for cross-border capital inflow (Chart 8).

On the catalyst level, beyond the peak of settlement, we focus on the potential benefits of the "good start" in 2026 and the further easing of China-US economic and trade relations.

After September this year, the overall trend of domestic demand-related indicators has been weak, and during the same period, fiscal spending has decreased while fiscal surpluses have increased. It cannot be ruled out that both fiscal and monetary policies are reserving "resources" for the "good start" in 2026. At the same time, the recently concluded Politburo and Central Economic Work Conference have shown considerable confidence in achieving the annual growth target for 2025, but have also set clear expectations for the "good start" in 2026 and the beginning of the 15th Five-Year Plan.

On the other hand, as President Trump's visit to China approaches in April next year, there may be further room for policy easing in the China-US economic and trade fields. A series of recent events, including the China-US economic and trade negotiations on October 25-26, the meeting between the two heads of state on October 30, the phone call between the two heads of state on November 24, and the preliminary schedule for Trump's visit to China next April, indicate that after a certain mutual check and balance of power between China and the US, the stability of the economic and trade relationship between the two countries has instead increased in stages Looking back at the RMB exchange rate trends since 2018, it is not difficult to see the direct impact of Sino-U.S. relations on the risk premium associated with Chinese assets, and a temporary warming of Sino-U.S. relations early next year cannot be ruled out (Chart 9). At the same time, we will continue to closely monitor policy dynamics related to tariffs, including whether the IEEPA tariffs will be overturned by the Supreme Court.

3. RMB appreciation is beneficial for the revaluation of related asset prices

In terms of market environment, we reiterate that the current stage of RMB appreciation (correcting undervaluation) is expected to enhance foreign investment's attention and risk appetite for RMB assets, forming a "positive cycle" with capital inflows, which is conducive to easing financial conditions.

As we have analyzed, in the classical sense, currency appreciation tightens financial conditions, but if it is correcting a significant undervaluation of the exchange rate and the appreciation speed is relatively "restrained" (i.e., appreciation expectations are not released all at once), the effect may be the opposite, and historical experience supports this observation.

• We believe that if the RMB is gradually appreciated in a managed manner under the expectation of appreciation, it may actually attract accelerated capital inflows (or reduce outflows), leading to improved market and interbank liquidity.
• Given that China's cost optimization speed is significantly faster than that of Europe and the United States, we believe that a moderate appreciation (annualized 4-5%) will not erode the competitiveness of total exports, but may instead reduce trade friction pressures.
• We believe that the current stage of RMB appreciation (correcting undervaluation) is expected to enhance foreign investment's attention and risk appetite for RMB assets, forming a "positive cycle" with capital inflows, which is conducive to easing financial conditions. Recent cross-border capital inflows have partially benefited from net inflows of securities investment driven by market recovery (Chart 10). Although the year-end capital flow and risk appetite indicators have seasonal declines, as the momentum of RMB appreciation further strengthens, the valuations of RMB assets, including onshore and offshore RMB assets, will continue to be boosted. We maintain our forecast of an exchange rate of 6.82 for USD/RMB by the end of 2026—this forecast implies that China's nominal GDP growth rate in USD terms may reach 8.5-9% next year, and the corresponding profit growth forecast will also be significantly raised. This nominal growth performance may prompt overseas funds to reassess the currently low relative allocation share of Chinese assets.

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