(Bloomberg) -- Brace yourself.
Beijing was embroiled in a spate of frenzied dollar-selling last month as capital outflows and a depreciating yuan saw foreign-exchange reserves tumble by $80 billion, resuming 2015's sharp declines in the country's monetary war chest after a period of relative stability between February and September this year.
That's the prediction of analysts Khoon Goh of Australia & New Zealand Banking Group Ltd, and Jens Nordvig of Exante Data LLC, a data-driven macro research firm, who reckon markets have underestimated the likely scale of currency intervention by the People's Bank of China in light of the fall of the yuan relative to the dollar.
Estimating the drop at $80 billion, they reckon Chinese currency reserves fell in October by more than four times the decline registered in the previous month. Their projection is in stark contrast to the median forecast of economists surveyed by Bloomberg, who expect a decline of $26 billion when the People's Bank of China releases the data on November 7.000
"China's FX reserves for October is likely to post a much bigger decline than what the market is expecting," Goh, head of Asia research at ANZ, wrote in a note on Thursday. "The drawdown in reserves in the month will be driven by FX intervention, negative currency valuation effects, and capital loss on fixed income investments," Goh concludes.
Nordvig's model uses real-time yuan trading data to forecast that foreign-currency reserves fell in October by the same margin estimated by the ANZ economist, an order of magnitude similar to falls in January 2016 and August 2015, which was fanned by concerns over the outlook of Chinese's currency and liquidity challenges.
"We have not seen such a large imbalance in the FX market since the first week of January, when markets were in a state of panic," Nordvig, a former head of currency research at Nomura Holdings Inc., wrote in a note to clients on Monday. The analyst, who was ranked top currency strategist by Institutional Investor between 2010 and 2015, estimates Chinese authorities sold $19.5 billion of foreign currency-denominated reserves to stabilize the yuan in the week of 24 October alone.
"In other words, there are notable cracks emerging under the surface: the fairly orderly depreciation of the Chinese currency over the last few weeks has been achieved only in the face of an aggressive currency intervention by the Chinese central bank," the Exante CEO wrote.
Goh estimates intervention costs at $35 billion and the effects of the yuan's depreciation — at $30 billion. The currency is down 4 percent this year against the dollar. Combine these figures with an estimated $15 billion mark-to-market losses on China's reserve portfolio, in the wake of the October bond rout, and China's FX reserves will tumble by $80 billion to $3.086 trillion, Goh concludes.
That projection is an outlier relative to consensus.
"I don't think that China would have a dramatic blowup" in its foreign-exchange data for October, Zhou Hao, economist at Commerzbank AG in Singapore said in a phone interview, estimating a more modest FX drawdown of $31 billion.
But Zhou cites the potential for elevated pressure on reserves over the next two months if the U.S. election paves the way for dollar strength and a Fed rate hike in December.
"We do not see reserve adequacy as an issue for China," Goh concludes. "But markets may start to get some angst if the headline FX reserves start to threaten the psychological $3 trillion mark."
While bevy of economic data over the past month paints a flattering picture on the Chinese real economy — feeding global optimism that disinflationary forces are abating — the apparent calm in the Chinese real economy belies the storm in an imbalanced currency market, testing the People's Bank of China's appetite for intervention.
To contact the authors of this story: Sid Verma in London at sverma100@bloomberg.net, Narae Kim in Hong Kong at nkim132@bloomberg.net.
To contact the editor responsible for this story: Isobel Finkel at ifinkel1@bloomberg.net, Joe Weisenthal
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