China has loosened the grip it holds on the Yuan, setting its daily reference rate above the 7,20 dollar per yuan mark. The escalating US-China trade war is forcing Beijing to make difficult decisions.
After the PBOC lowered the target rate of the yuan from 7.2038/dollar to 7.3363, it was the lowest level in September 2023.
Investors had viewed the threshold as a redline unofficially signaling China’s tolerance of a weaker dollar.
This move caused a rapid drop in spot yuan before it recovered some of its ground.
Although the broader markets showed signs of improvement, currency traders were already anxious about the US-China trade war.
Stephen Innes says that the Chinese yuan is now past the line in the sand.
Beijing is quietly signaling that something bigger may be on the way. This was something we flagged yesterday even though certain anti-Trump corners of the media tried to portray a weaker Yuan as a kind export booster. Devaluation, let’s face it, is not a stimulus. It’s desperate. He warned that it could have serious consequences.
The currency strategy is caught in the middle of trade and capital flight concerns
Beijing is under increasing pressure from Washington to boost its exports, which are now in a weakened state due to the aggressive tariff increases.
Weaker yuan could make Chinese products more competitive abroad, possibly offsetting the damages from American tariffs.
The decision to relax currency controls comes with some risks.
Rapid depreciation of the dollar could cause capital outflows and unsettled financial markets. It would also further antagonise Washington, at a moment when prospects for trade talks have been dimmed.
Source: Forexlive
China devalued its yuan in 2015 as a response to the economic downturn and to boost exports. This move shocked the markets, and they went into a risk-off state as people were worried that China’s economic growth was lower than anticipated.
The US stock market fell more than 10% in response.
Dellamotta stated that if China continues to pursue the strategy of devaluing the yuan, this could escalate the trade war because Trump will not be pleased as he has branded China as “currency manipulation” for quite some time.
He said that the markets would likely be expecting a worse response, and fear and unease will probably weigh even more on the stock exchange.
Keep the exchange rate artificially high can also have downsides. It could curb exports or lead to a more severe correction if all of the depreciation pressure is released at once.
Becky Liu of Standard Chartered Bank’s China macro strategy noted that “the fixing” could be a change in China’s exchange regime to a managed depreciation, rather than limiting the spot yuan at 7%.
Beijing under pressure from rising tariffs
Trump warned on Monday that he would impose an extra 50% tariff on Chinese goods if Beijing did not abandon its plans for retaliation.
China’s Ministry of Commerce responded by pledging to “fight until the end” and announcing countermeasures, including tariffs against all US products as well as export controls for critical rare-earth minerals.
Since the beginning of Trump’s presidency, traders have been expecting a possible recalibration in China’s currency policy. However, the Chinese government has consistently vowed to keep the yuan stable and prevent excessive fluctuations in exchange rates.
Investors are now closely watching the Central Bank of China for any new signals on the bank’s stance towards the yuan and whether Beijing will restart its monetary ease.
The developments of the last week show very clearly that we were wrong to argue for half a year about the intentional depreciation of the yuan in order to offset the tariffs, said Lynn Song. Chief economist for Greater China for ING Think.
She said that any gain in competitiveness would be outweighed by the harm caused to domestic purchasing power, market confidence and trade.
Analysts expect gradual flexibility in the yuan
Analysts are increasingly predicting that the yuan will continue to drop, but most believe the PBOC will proceed with caution.
Wells Fargo & Co. believes that there is a risk of an intentional depreciation up to 15% over a period of two months.
Brad Bechtel is the global head of FX for Jefferies Financial.
Most expect a more gradual move, since a sudden devaluation would accelerate capital flows and further undermine investor confidence.
The PBOC can manage volatility in the market even if a bearish mood gains momentum.
It has in the past used methods like adjusting foreign exchange liquidity and issuing bills offshore to stop the decline of the yuan.
Ken Cheung is chief Asia FX Strategist at Mizuho Bank Ltd. He said that a sharp yuan decline was unlikely because of capital outflow risk.
The PBOC also intends to maintain FX stability in order to have more room for monetary easing.
Post: The Yuan’s Decline: Risks amid Trade Tensions, and How Far Will China Let It Fall? This post may change as new information becomes available
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