Chinese currency weakness may have run its course

Thought of the day

by Chief Investment Office 27 Jun 2018

The Chinese yuan is at a six-month low after falling over 3% against the US dollar, to 6.6. This rapid shift has raised market speculation that China could be weakening its currency to soften the impact of pending US trade tariffs.

But we see at least three reasons why yuan devaluation is likely over:

  • Though today’s USDCNY fix (the midpoint in its daily 2% trading channel) was its lowest in six months, it was set stronger than markets projected, suggesting that the People's Bank of China may be acting to slow the currency’s decline. The option market is pricing in very minimal CNY depreciation.
  • Letting the yuan fall too much would pose its own risks for China, since deeper devaluation, or even anticipation of it, could spark capital flight pressure. Though capital controls would limit the chances of a repeat of 2015 outflows, authorities are likely to keep market expectations on the balanced side.
  • Our base case remains for a broad decline in the dollar over the next three, six and 12 months. This should help bolster the yuan on a bilateral basis. Of course, we are alert for dollar upside risk too.

While trade risks and softer economic growth could push the yuan still lower, these risks are likely to play out on a trade-weighted basis rather than against the dollar. Our base case is for China and the US to reach a negotiated trade settlement, and we do not expect China to engage in significant retaliatory devaluation.

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