China’s central bank has set its daily reference rate for the yuan nearly in line with market expectations for the first time in over a year, signaling its comfort with the current currency levels following a recent rebound. The People’s Bank of China (PBOC) set the fixing just seven pips away from the median estimate in a Bloomberg survey of analysts and traders, marking the smallest gap since June 2023.
The yuan has recovered much of its losses against the dollar this year as the dollar weakened on expectations of Federal Reserve rate cuts next month. Additionally, trades that involved borrowing the yuan cheaply and selling it for higher-yielding currencies have begun to unwind. Analysts anticipate that the PBOC will step in to curb any sharp gains in the yuan that could negatively impact exporters and hinder economic recovery.
Becky Liu, head of China macro strategy at Standard Chartered Bank, commented on the PBOC’s strategy, stating, “The move signals a reluctance to let the yuan strengthen too much. We currently see the dollar-yuan exchange rate at 7.10-7 by year-end.”
Over the past year, China has intervened to prevent rapid depreciation of the yuan, using the fixing to support the currency amid weak economic prospects and a significant yield discount compared to the US. Additionally, state banks’ dollar sales have played a crucial role in stabilizing the exchange rate.
However, the PBOC has gradually eased its grip on the fixing in recent months, following calls from former officials to allow more flexibility to create space for further monetary easing. A weaker yuan had previously posed a challenge to additional central bank stimulus, as lower yields in China would further reduce the attractiveness of local assets compared to those in other countries.
Despite ongoing concerns about China’s sluggish economy, the dollar’s decline has led to the yuan’s first back-to-back monthly gain this year. Traders are now more focused on hedging against the yuan’s rise rather than a fall. Although the onshore yuan has risen more than 1% this month, its gains are modest compared to the Indonesian rupiah and Malaysian ringgit, which have surged by around 5% in the same period.
Looking ahead, there are risks to the yuan’s rally. Kiyong Seong, lead Asia macro strategist at Societe Generale SA in Hong Kong, warned that a potential victory by Donald Trump in the upcoming US presidential election could lead to a weaker yuan due to the possible imposition of higher tariffs. “If the yuan has rallied significantly before the election, the resulting FX volatility is likely to be larger,” Seong noted.
China’s foreign exchange regulator is reportedly taking precautions to assess the impact of a stronger yuan on the country’s exporters, which have been crucial in helping China recover from an economic slowdown. This caution may indicate that authorities are wary of the yuan’s recent gains.
The offshore yuan slipped 0.1% to 7.1271 per dollar on Wednesday, while the onshore rate remained relatively stable. The PBOC set the fixing at 7.1307, allowing the domestically traded currency to fluctuate by 2% on either side of this rate.
Ken Cheung, chief Asian FX strategist at Mizuho Bank, suggested that further yuan strengthening could occur due to pending FX settlements and the diminishing impact of seasonal dividend payouts amidst the ongoing dollar selloff. However, he also expressed caution regarding the yuan’s depreciation risk, citing weak Chinese economic fundamentals and uncertainties surrounding the US elections later this year.
