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YINAN, CHINA – DECEMBER 26, 2024: A worker counts RMB bills during a meeting to distribute the annual dividend to members of an agricultural cooperative in Yinan County, east China’s Shandong Province, Thursday, December 26, 2024.
Wang Yanbing | Future Publishing | Getty Images
The Chinese yuan is widely expected to depreciate against a rising US dollar. A more thorny question confronting market watchers: How far and fast could the currency slide?
The stake is huge. The impact of a pronounced weakness in the yuan could not only affect the entire world by reducing export competitiveness for countries that compete with China to sell goods and services to the world, but also jeopardize the efforts of the Chinese authorities to turbocharge the growth in the second largest in the world. economy
China’s offshore yuan has lost more than 3% since Donald Trump’s presidential election victory in early November, as the outlook for monetary policy in the United States and China diverged. The tightly controlled yuan has also retreated close a minimum of 16 months.
Many investors are gloomy about China’s prospects. The country is facing a real estate crisis and tepid consumer spending. With market participants worried about deflation and banks struggling to rein in demand for loans, there has been a flood of funds. in government bondsdriving yields to record lows.
In contrast, the decision-makers of the Federal Reserve of the United States now anticipate fewer rate cuts than they did before. The higher tariffs proposed by incoming US President Donald Trump, if materialized, could fuel inflation and slow the Federal Reserve’s easing cycle. keeping interest rates, and consequently bond yields, raised further.
The performance on the 10-year US Treasury has been growing steadily since June and exceeded 4.7% this month, a level last seen in April. U US dollar indexwhich measures the greenback against six other currencies, rose near a 26-month high.
Markets have reduced expectations for the number of rate cuts by the US Federal Reserve this year, pricing in just a quarter percent cut in 2025, according to to the CME FedWatch tool from Friday.
With the yield gap between US debt and its Chinese counterpart widening, investors have pushed the dollar and dragged the yuan lower.
“Orderly Decline”
Market gyrations are testing policymakers’ resolve. While a weaker yuan should help improve the appeal of Chinese exports, authorities also want to avoid a sharp fall in the currency that could spark excessive volatility.
In an attempt to raise bond yields, the People’s Bank of China suspended its purchases of government bonds last week, citing excess demand in the market, while growing issuing invoices in Hong Kong to help stem the decline of the yuan.
The central bank has lately increased ads to warn against speculating against the currency and signaled that the bullish race in government bonds could undermine financial stability.
“We resolutely prevent the risk of the overshooting of the exchange rate, ensuring that the exchange rate of the yuan remains generally stable at a reasonable and balanced level.” PBOC Governor Pan Gongsheng said last week.
That echoed the sentiment in a separate press conference last Tuesday where senior officials reiterated the position of moderately loose monetary policy, while stressing the importance of FX stability.
“Such communication implied that the PBOC could prioritize FX stability over short-term monetary policy easing,” Goldman Sachs economists said in a note last week.
On Monday, the central bank kept benchmark lending rates unchanged as it strives to keep the currency stable.
However, the offshore yuan could weaken to 8.5 per US dollar by the end of the year, said David Roche, a strategist at Quantum Strategy, in a scenario of Trump imposing the promised 50%-60% tariffs on goods Chinese
The latter currency traded at 7.3357 against the greenback on Monday.
“The Chinese authorities will try to make the yuan decline in order,” said Roche, while warning that Beijing’s stimulus measures were “insufficient” to do more than stabilize the economy, as they failed to address the problems key as slow demand and excessive household savings. .
Priority to the yuan
Pan Gongsheng, governor of the People’s Bank of China (PBOC), during the Asian Financial Forum in Hong Kong, China, Monday, January 13, 2025.
Lam Yik | Bloomberg | Getty Images
The central bank is likely to refrain from cutting interest rates sharply in the near term, despite the growing pressure on domestic growth, said Helen Qiao, China and Asia economist at Bank of America, given the temporary political priority on the exchange rate stability.
She expected the central bank to continue to defend the currency with tighter capital controls and liquidity guidance to financial institutions.
While the hawkish Fed limits the room for PBOC to lower interest rates, Beijing still has many policy tools to prevent excessive currency movements, including verbal intervention, adjustment of offshore liquidity via bill issuance , and “bringing up state-owned financial companies to buy directly. CNH [offshore yuan]” said Lynn Song, China’s chief LNG economist.
For the onshore market, a primary tool used by the PBOC to manage the currency has been the daily reference rate – the onshore yuan is only allowed to trade within a 2% range of this reference rate. Since last year, the central bank maintains the guidance of the exchange rate stronger than 7.20 per dollardespite a rising greenback.
The yuan onshore was settled at 7.1886 per dollar on Mondaybut the markets pushed it to the weaker side of the band, and it was last trading at 7.3249.
Exports in play
China’s economic activity has accelerated more than expected in the last quarter of 2024supported by robust exports as businesses face shipments ahead of tariff hikes, but experts have warned that growth momentum could fade later this year as Trump’s tariff hikes come into play.
“Beijing does not want to see a collapse in the currency in advance of knowing what the situation is,” said Kamil Dimmich, portfolio manager of the North of South Capital, alluding to the uncertainty about the size and pace of l tariff increase by the Trump administration.
Trump, who will take office on Monday, has promised universal tariffs of 10% to 20% on all imported goods, and 60% or higher on shipments from China, although some believe the tariffs will be imposed gradually.
“Although the rate hike could be bigger in trade war 2.0, the scope of the yuan’s depreciation may be much smaller this time,” said Larry Hu, chief economist at Macquarie, as Beijing has indicated his political preference for a “relatively stable”. yuan”.
He projected the offshore yuan to peak at 7.50 per dollar in the third quarter of this year.
