Chinese authorities have introduced a raft of tried-and-true manoeuvers in recent weeks to ease the yuan’s slide, showing relative success in comparison to other battered currencies, but analysts say they have no chance against an unstoppable dollar.
The increased efforts, taken as the yuan plunged about 7% from mid-August to a 14-year-low around 7.25 per dollar on Sept. 28, range from unexpectedly strong signals to the market – last week the central bank told state-owned banks to make preparations to sell dollars – to administrative measures that increase the cost of shorting the yuan.
That helped the yuan to recover some traction against the dollar, which also slowed down against other currencies, but analysts expect the yuan to depreciate further in coming months with a risk of volatile gyrations along the way. SEB said in a note:
“Considering the strength of the dollar, we now expect (the dollar/yuan rate) to trade around 7.40 around October and November.”
While that was among the more gloomy forecasts, Goldman Sachs and ANZ saw a yuan rate of 7.20 per dollar within the next quarter or so, with Goldman also noting increased dollar/yuan risks, and Citi said it could reach 7.3 in a strong dollar environment. The yuan late on Friday was trading close to 7.12 per dollar.
In a sign that investors do not expect the new measures to reduce swings in the yuan, expectations of future volatility priced into one-month yuan options have grown twice in the past month. For Chinese authorities, who were especially determined to stabilize the yuan rate before a week-long national holiday in China this week, the stakes are high.
This is a politically sensitive time for China’s ruling Communist Party, which is expected to open its once-in-five-years congress on Oct. 16. President Xi Jinping is likely to get a precedent-breaking third term during the gathering.
A weaker Yuan also risks triggering financial instability stoked by capital outflows. Foreign investors reduced holdings of Chinese bonds for the seventh month in a row in August.
On the monetary policy front, the weaker yuan, stoked by the wide gap between low Chinese interest rates and increasing U.S. rates, makes it more difficult to ease policy to help China’s reeling economy, the world’s second-biggest.
The yield gap between China’s benchmark 10-year government bonds and the U.S. Treasury for the same tenor is near the broadest in 15 years.
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Analysts do not foresee Beijing setting up a serious defense of any particular level for the yuan, in comparison to the previous two times the yuan broke through the psychologically significant 7 to the dollar level in 2019 and 2020, during the peak of China-U.S. trade tensions and the initial flare-up of COVID-19.
Ju Wang, head of Greater China FX and rates strategy at BNP Paribas, said:
“The central bank needs to play a balance between being market-oriented and also ensuring financial stability. Hence the official line will still be ‘no-lines-in-the-sand-but-two-way-volatility’.”
China’s economy also gains some benefit from yuan weakness, which boosts its exports by making them fairly cheaper in dollar terms. The export sector has become a major pillar for the economy as it battles a property crisis and COVID outbreaks.
Further, the yuan has not dropped sharply against the greenback as have the yen, the euro, and other top currencies this year, keeping the yuan remarkably resilient against a basket of currencies of China’s main trading partners, with a slump of only 1.4% year-to-date.
Chinese authorities, who have stressed that they want to make the yuan more international and market-driven, are seeking not to control the long-term value of the yuan, but to hinder an unexpected short-term depreciation that would delay its economy and capital flows, analysts said.
Khoon Goh, head of Asia research at ANZ, added:
“As China goes on a week-long holiday, the threat of intervention in the offshore yuan could keep a lid on near-term depreciation.”
Mainland China’s financial markets are closed for the National Day holiday from October 1, during which there will be no onshore trade or daily guidance through midpoint settings. Trading continues on Oct. 10.
Goh added, however, that how long the news threat continues to be successful is contingent on the dollar’s trend.
“While the authorities will want to maintain FX stability into the Party Congress, the widening yield differential between the U.S. and China could still see yuan weakness re-emerge later in the year.”
