Nobody wants a weaker yuan. We may still get one.

Thought of the day

by Chief Investment Office 20 Feb 2019

As high-level US-China trade talks resume in Washington today, negotiators appear to have reached a rare point of agreement. According to Bloomberg, the US and China have tentatively agreed to keep the value of the yuan stable as part of the framework for a broader trade deal. The report prompted a 0.5% gain for the yuan against the dollar, and the currency has now rallied 3.6% since the start of December. In effect, neither side wants to see a significant fall in the yuan, with Washington worried it would blunt the impact of its tariffs, and Beijing wary of adding to outflow pressure or FX instability.

While this news should offer near-term support for the yuan, we see several reasons why the currency could still weaken in the later stages of the year:

  • Macro headwinds: The Chinese economy continues to decelerate. January's PMI was again in contractionary territory, and retail sales dipped to a single-digit growth rate for the first time in a decade. We expect full-year GDP growth to slow to 6.1% this year from 6.6% last, and we recently downshifted our quarterly projections.
  • A vanishing current account: In 1Q18, China experienced its first quarterly current account deficit in almost 18 years. This pressure remains, with the trade surplus component likely to narrow again this year, especially in the event that China strikes a trade deal with the US.
  • No deal yet: News reports and official comments on US-China trade talks have turned positive, raising market expectations that a resolution is on the cards. This is likely already priced into FX markets. But we believe an extension to the tariff pause is likelier than a substantive and long-lasting deal as deep-seated structural differences remain over technology and industrial policy.In short, reports of a currency deal in US-China trade talks are in line with our expectations for a stable USDCNY exchange rate in the short term. Over a longer horizon, the yuan’s bias remains tilted to depreciation, and we are keeping our USDCNY target of 7.0 over six and 12 months. We continue to recommend that investors reduce their CNY long exposure and eliminate unnecessary currency risks.

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