SINGAPORE (Reuters) – Financial markets are betting China will not use the yuan as a policy tool to offset expected U.S. tariffs during a second Donald Trump presidency, based on the view that a sharp depreciation like the one seen during his first term would be more damaging will be than the yuan. helpful for the struggling economy.
From the yuan’s pricing to interest rate derivatives and analyst forecasts, there are indications that China is already allowing a slow depreciation of the yuan to adjust to a broadly stronger dollar as the country braces for Trump 2.0.
But the pricing also shows that investors expect a gradual, moderate decline in value, with sell-side analysts seeing a 5-6% decline from current levels by year-end.
During Trump’s first term as president, the yuan was allowed to weaken more than 12% against the dollar between March 2018 and May 2020 during a series of tit-for-tat US-China tariff announcements.
Trump has threatened tariffs of up to 60% on imports of Chinese goods during his second term starting Monday, although some reports suggest the duties could be increased gradually.
But now things are different, analysts say. The yuan is already weak, the economy is fragile, wallet money has left China and exports to America are a smaller share of total global trade, too small to justify a major devaluation.
The yuan, or renminbi as it is also known, has been at a 16-month low against the dollar for days and has fallen for three years in a row. In 2018, it was near a record high of $6.3 per dollar.
Reuters reported last month that there were discussions in official circles about a drop to 7.5 per dollar, a decline of roughly 2% from current levels.
However, most of that depreciation is likely to come from interest rate differentials between the US and China, which have widened to around 300 basis points.
The dollar has already increased to its current level of around 7.3 yuan, and “to break this level significantly higher is not realistic,” said Ju Wang, head of Greater China FX and Rates Strategy at BNP Paribas (OTC:).
Wang pointed out that nearly half of China’s $1 trillion trade surplus was with countries other than the United States, especially neighboring countries such as Vietnam, which have grown as a hub for finishing Chinese industrial goods.
In both the 2015 and 2019 periods of sharp declines in the yuan, China was forced to defend its policies and explain that it was not engaging in any form of devaluation of the currency. A cheaper exchange rate helps exporters by making their prices more competitive internationally.
“There is a responsibility on China’s part to keep the currency relatively stable, because you still have a fairly large trade surplus with the rest of the world. The world cannot afford a one-to-one adjustment of the dollar-yuan against the rate. Wang said.
When asked about the yuan, the People’s Bank of China (PBOC) told Reuters on Friday that the country has sufficient foreign exchange reserves and more experience in responding to external shocks… “so it has the confidence, conditions and ability to maintain the renminbi.” exchange rate fundamentally stable at a reasonable equilibrium level”.
STABILITY IS KEY
Domestic considerations about the sluggish economy also call for a stable financial system and currency so that residents and businesses cannot shift their savings abroad.
Falling domestic bond yields and shaky stock and real estate markets have accelerated the rush to hoard dollars.
“If the renminbi becomes a very unstable currency, people will try to convert it into US dollars, buy gold and so on. That is not what the PBOC wants,” said Vincent Chan, China strategist at Aletheia Capital.
While it has been difficult to interpret the PBOC’s plans for the yuan, it has done everything it can to limit the currency’s weakness, so much so that it remains strong in trade-weighted terms.
The trade-weighted CFETS yuan index, which measures the Chinese currency against a basket of 25 peers, remains near its highest level in more than two years, showing the yuan remains slightly less competitive than the year-to-date currencies of its trading partners.
The authorities have set a floor for falling domestic interest rates, including by suspending the bond purchase program. They have encouraged companies to borrow abroad to bring home more dollars, and the central bank has often set the yuan’s trading band at a stronger level than market expectations.
While Chinese leaders pledged in December to ease monetary policy and take other steps to support economic growth through 2025, interest rate swaps show markets are pricing in the chances of rate cuts as they believe the PBOC will prioritize stability of the yuan.
Alps Macro (BCBA:)’s China strategist Yan Wang sees the 7.7 dollar/yuan level as the upper limit for the PBOC, implying a further decline of around 5%.
“Short-term pressure on the yuan could be difficult to avoid,” said Vishnu Varathan, head of macro research for Asia ex-Japan at Mizuho (NYSE:). “But it can be managed in such a way that the trade-weighted stability of the yuan is not unnecessarily jeopardized.”
($1 = 7.3317 renminbi)
