Stable yuan sentiment may be tested amid volatile US-China relations

Market sentiment in the yuan has improved as China’s capital outflows ease, but risk factors such as the unpredictable Trump administration and US dollar strength could still affect the exchange rate, said analysts.

The People’s Bank of China has been keeping a tight grip on capital flows in order to stabilise the yuan, meaning that internationalisation of the currency has taken a step back despite a small move last month in relaxing capital controls. The PBOC scrapped a restriction requiring commercial banks to stop processing cross-border yuan payments unless they could show at the end of each month that the amount of outbound yuan matched the sum that came in.

Meanwhile, the US-China relationship is at a crucial juncture for global investors. Whereas past US administrations didn’t link cooperation on trade or issues like climate change with dissatisfaction over North Korea or currency manipulation, the Trump administration appears to be breaking from this tradition by making trade cooperation conditional on Chinese concessions.

“US decisions pushing for greater liberalisation in China’s economy or increased tariffs may be one of the most important policy choices facing the global economy,” Alex Wolf, senior emerging markets economist Standard Life Investments said. “On the other hand, inability to overcome geopolitical hostilities would result in reduced flow of goods, services and investment.”

President Xi Jinping is aiming to increase China’s influence as a global superpower so the Communist Party can claim legitimacy even as GDP growth slows from 6.7 per cent last year to a target of 6.5 per cent this year.

The Trump administration appears less willing to challenge China as it seeks to expand its influence and the US may also look the other way on the South China Sea and on China’s human rights record in exchange for greater cooperation on North Korea and market access for US firms and goods, Wolf said.

Jeremy Cook, chief economist and head of currency strategy at fintech company World First, said this new approach may be good news for investors and foreign companies which want to see China as a stable superpower. However, he added that international trade issues between the US and China seem delayed for now and progress will depend on negotiations going forward.