Forex ‘regime change’ has arrived, as analysts forecast weaker yuan in 2016

Recent price action and lack of intervention by PBOC show growing tolerance for depreciation

PUBLISHED : Tuesday, 22 December, 2015, 12:26pm
UPDATED : Tuesday, 22 December, 2015, 12:26pm

Currency analysts compiling their year-ahead outlooks are grappling with the difficult problem of gauging just what’s in store for the Chinese currency.

A year ago, it seemed hardly anyone had flagged up the possibility of the yuan losing ground against the US dollar, as the mindset of gradual appreciation, or what some called the “speed limit” of 3 to 4 per cent annual appreciation against the greenback, remained firmly entrenched. Now, the idea of the yuan holding its own against the US dollar, let alone appreciating, is deeply out of favour. Many analysts have been hunkering down over recent weeks to rethink where they expect the currency to trade in the new year - and for the most part that means, deeper write downs on the currency.

Christy Tan, head of markets strategy research of Asia of National Australia Bank, believes what lies ahead could be a soft patch for the Chinese currency. While she remains optimistic about the value of the yuan longer term, a period of depreciation is likely, judging by the changing behaviour of the PBOC, which seems content with a further weakening in the currency.

“We are sensing that the recent price actions and corresponding ‘inaction’ by the PBOC could be the real start of an foreign exchange regime shift,” she said. “Heavy intervention is probably a thing of the past. The PBOC has to allow CNY to be more market-oriented and heavy intervention is not sustainable.”

We are sensing that the recent price actions and corresponding ‘inaction’ by the PBOC could be the real start of an foreign exchange regime shift
Christy Tan, head of markets strategy research of Asia of National Australia Bank

Heng Koon-how, senior foreign exchange strategist of Credit Suisse, on Monday downgraded his outlook on the yuan to 6.80 per US dollar in 12 months, down from 6.60 per US dollar previously.

“We hereby downgrade the CNY further and see more weakness,” wrote Heng in the report, announcing his revised targets for the yuan over a three month (6.55 per US dollar) and 12 month basis.

“There are increasing signs that suggest that there may be more weakness ahead,” Heng said.

Since the International Monetary Fund on November 30 announced it would include the yuan into the Special Drawing Rights currency reserve basket in October next year, the onshore yuan has been on a steady weakening trend.

The yuan fell to a more than 4-year low last week in the wake of the decision by the US to hike interest rates for the first time in a decade.

Heng said the recent weakness of the yuan this month suggests that the People’s Bank of China has stepped away from active intervention against the on-shore yuan weakness.

This is expected by the currency traders, as they believe after the IMF announcement on the SDR basket, China would need to let its currency to trade more according to market forces.

“Objectively speaking, a lighter intervention touch from the PBOC is a step in the right direction toward the eventual long-term goal of a freely floating onshore yuan with more two-way flexible trading,” Heng said.

“This goes in line with the PBOC’s long-held objective to elevate the onshore yuan into a global reserve currency. However, a lighter intervention touch from the PBOC would also imply that existing negative market forces will take over and drive the yuan weaker.”

He believes the persistent capital outflows, ongoing drawdown of foreign reserves, more aggressive monetary policy easing and weak onshore sentiment continue to weigh on the onshore yuan.

National Australia Bank’s Tan also believe the weaker trend of the yuan will continue in 2016.

The gap between the onshore yuan and offshore yuan has widened as market conviction in a more market oriented currency took firmer hold, Tan said in a report on Monday.

Tan pointed out the 12 month offshore yuan forwards have climbed to around 2000 points, indicating expectations for about 3 per cent depreciation, which she described as “still rather contained and not exactly a crisis scenario.”

“On balance, we believe that the CNY will stay on a consolidation path in 2016, from a position of strength,” Tan said.