Pressure mounts on Beijing to allow the renminbi to weaken

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Market pressure is mounting on the People’s Bank of China to allow the renminbi to weaken, as traders bet that the widening gap with US borrowing costs will lead more investors to sell out of the Chinese currency.

China’s central bank has maintained a dovish policy on the yuan so far this year, keeping its daily peg – or the benchmark rate around which the currency is allowed to trade – within an extremely tight range of 7.09 to 7.11 against the dollar. American.

But the currency has recently traded as much as 2 percent below the fixed rate – the maximum variation the central bank has said it will allow – for the first time in eight years, indicating mounting selling pressure.

Markets are pushing for a weaker yuan to reflect the gap in bond yields with the US – 10-year Treasury yields are trading at 4.57 percent, while 10-year Chinese government bonds offer just 2.3 percent . Capital tends to flow to markets where interest rates are higher.

“A large number of traders expect a one-time devaluation of the yuan, similar to what happened in 2015, due to the huge downward pressure that has built up over the past few months,” said a Shanghai-based currency trader.

In 2015, China suddenly devalued the renminbi, which it considered overvalued. That sparked turmoil in financial markets, including sharp selling of the yuan by global managers, huge capital outflows and a 1 trillion Rmb drop in the country’s foreign reserves, as regulators stepped in to try to calm markets.

The central bank is reluctant to allow a rapid shift in the exchange rate, favoring stability. President Xi Jinping spoke of “a strong currency” as one of his top priorities earlier this year as part of plans to strengthen China’s status as a financial power. A devaluation of the renminbi would have major implications for global trade, potentially inflaming tensions with Washington by increasing the competitiveness of Chinese exports to the US.

Asked about the gap between peg rates and spot rates, the PBoC said it had “the confidence, conditions and ability to maintain the basic stability of the renminbi exchange rate at a reasonable and balanced level” and would “prevent with determination, the risk of exchange exceeding the rate”.

Import and export data had improved this year, the central bank said, adding: “As a series of macro policies gradually take effect, China’s economic recovery will further consolidate and strengthen, supporting the renminbi exchange rate.”

High interest rates in Western economies – particularly in the US – have recently fueled an even greater decline in other Asian currencies against the dollar.

While the yuan has weakened about 2 percent against the U.S. dollar this year, the Japanese yen has fallen more than 11 percent and the Korean won has fallen more than 5 percent. Both are trade competitors with China.

Analysts are divided on which way the Chinese currency will move next.

“Yuan bears still dominate the market at the moment,” said Tiffany Wang, a China foreign exchange and rates strategist at JPMorgan, with many investors pointing to the gap in interest rates.

While the US Federal Reserve is expected to start cutting rates later this year, “a shallower tapering cycle this time will keep US yields above China for the foreseeable future,” she said.

The PBoC has said it would like to keep interest rates low or cut them if required, responding to weakness in China’s economy following the coronavirus pandemic and a property market crisis.

Some traders meanwhile believe the yuan could suffer if Donald Trump wins the US presidential election in November and raises tariffs on Chinese goods.

IMF First Deputy Managing Director Gita Gopinath urged Beijing on Wednesday to consider allowing more flexibility in its exchange rate, saying it would “reduce deflationary risks and help absorb shocks from external”.

Despite market pressure, however, the PBoC has not signaled any plans to change course.

Kevin Liu, chief offshore China and overseas strategist at CICC Research, said it would send a mixed signal if China weakened the yuan even as it increased central government investment in an effort to boost growth. The recent issuance of long-term bonds should provide a “positive catalyst” to support the currency, he said, as more central government spending should support the economy in the medium term.

From a simple trading perspective, the yuan is not overvalued, said Chen Long, co-founder of Plenum, a Beijing-based consultancy.

“China’s export growth has been strong, and the renminbi usually gains against the US dollar under such circumstances,” Chen said.

However, the PBoC’s reluctance to allow the yuan to weaken against the dollar is a clear departure from its previous policy of tracking a basket of currencies. This has left the central bank uncomfortably exposed.

A currency trader at a state-owned bank in Beijing said monetary authorities were weighing how to release pent-up market pressures on the yuan, for example by allowing a gradual loosening of pegs. Traders at Citic Securities believe the central bank could slowly ease the key rate towards 7.11 to 7.12 per dollar over the coming weeks, avoiding any sharp moves.

Additional reporting by Joseph Leahy in Beijing