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

US-China relationship at a crucial juncture for global investors, with geopolitical factors threatening to reduce the flow of goods, services and investment

PUBLISHED : Wednesday, 03 May, 2017, 6:10pm
UPDATED : Wednesday, 03 May, 2017, 10:39pm

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.

China eases yuan outflow controls in sign of recovered confidence

Another major development for investors to watch is the US Federal Reserve which is expected to hold interest rates steady at the end of its two-day meeting on Wednesday, while hinting it is on track for an increase in June. However, analysts said the market may prefer to focus on Friday’s non-farm payroll data as a key barometer for the Fed’s June rate increase.

Recent weak US economic data in manufacturing, consumer spending and auto sales is contributing to expectations that the Fed may eventually take a more dovish view on interest rate increases over the remainder of the year, which could provide some support to emerging markets.

“What would help the Chinese yuan gain some momentum would be if the Fed hinted that the gradual weakness in recent US economic data is going to encourage the central bank to pause its ambitions to raise US interest rates at least another two times before the end of 2017”, Jameel Ahmad, vice president of corporate development and market research at FXTM wrote in recent research note.

People who are still expecting USD/CNY to reach 7.00 by year end may end up being disappointed
Jeremy Cook, chief economist, World First

Wolf said the PBOC’s latest strategy has been to follow the dollar down in broad trade weighted terms but not follow it up, so a weak dollar means the USD/CNY rate will be stable but a strong dollar likely means the yuan will depreciate.

In contrast, if the dollar weakens the CFETS renminbi index, which measures the yuan’s performance against a basket of currencies, will also likely weaken, whereas if the US dollar strengthens the CFETS renminbi index will be stable.

This could mean the yuan surprises the market by staying stable this year rather than following the market consensus at the beginning of the year for a 5-10 per cent drop after last year’s 7 per cent depreciation, according to a research note from Macquarie.

“People who are still expecting USD/CNY to reach 7.00 by year end may end up being disappointed,” Cook said.