UBS Equities-Global Strategy _China Equities Roar - Will CNH Catch Up_ A...-117453696

ab26 August 2025Global ResearchGlobal Strategy China Equities Roar - Will CNH Catch Up?CNH: We see room for near-term catch-up gainsRising Fed rate cut expectations, and liquidity driven rebound in Chinese equities are buoying the CNH. This sentiment shift got a boost from the recent decline in daily CNY fixings. With our colleagues' sustained optimism on equities, China's BoP flows position being supportive of FX, an improvement in CNH's fair value to 7.00 on our models, and positioning being moderately short the yuan, we see scope for near-term catch-up gains. We recommend buying 3m USD/CNH 7.00 digital put, and think any such move would be a volatility accretive event. Meanwhile, we hold 1s5s NDIRS steepeners as an expression of equities' driven impact on fixed income markets.Recent daily fix signals some tolerance for modest FX strengthPBoC has been allowing a gradual pass-through of dollar weakness since mid-April, although onshore sentiment didn't embrace it - keeping spot renminbi stuck around 7.18. What's changing? 1) The 25th August USD/CNY fix recorded an unusual decline (second largest YTD, 97th %ile since PBoC's tight FX management began in 2H23). The rolling 20d sensitivity of daily fixes to broad dollar surged to its highest since 4Q24, implying modestly higher tolerance for RMB strength. Given the significance of the authorities guidance in this managed float - it's an important development. 2) Onshore market acknowledged this shift, with the FX pair making new YTD lows; we see scope for an uptick in exporters' conversion ratio into the Y/E.Fed cuts, equities could drive modest gains. Tariffs key for a large adjustmentCNH's ambivalence to the YTD dollar weakness likely reflected a policy choice to preserve exports competitiveness. Indeed, trade weighted yuan's 5ppt decline since Jan, alongside trade diversion to RoW, acted as a tariffs shock absorber. As such, a large reset lower in USD/CNH to sub 7.00 would also need an improvement in US-CN trade relations. We think for CNY TWI to rise by 2-3%, a moderation of the incremental tariffs on China (by US) from ~35ppt currently to ~20ppt might be needed. However, if the ongoing equities optimism sustains, and Fed delivers a front-loaded cutting cycle in 2H (UBSe: -100bps), CNH's slide to 7.00-7.05 range might not be a big ask.CTAs positioning would accelerate $/CNH’s decline, FX vols reboundIf the daily fixings' support continues, an unwind of CTA positioning and CNH funded carry trades could propel USD/CNH lower from 7.15 to 7.00-7.05 range. This seemingly small move carries only a 15-20% probability on FX options' probability distributions curve over a 3m horizon, and hence would be vol accretive. UBS CTAs’ positioning monitor estimates that such funds’ relative short CNH positioning vs. the broad dollar is extreme. Even a modest 1% move lower in FX (over a fortnight), could catalyze USD 20bn$ selling by such strategies. Passing of CNH’s dividends adds to this tailwind,