Portfolio | Fed's interest rate move to have 'limited' impact on yuan
US rate rise would add depreciation pressure to yuan but not enough to destabilise the markets
Investors are wondering if an interest rate increase by the US Federal Reserve will trigger further capital outflows in China, adding to pressures already weighing negatively on the yuan.
The Fed funds futures assign a 30 per cent probability of a quarter-percentage point rate increase on Thursday, which reflects the majority view that a rate rise this week is unlikely. Analysts seeking to discern the impact of an eventual rate rise believe it will pile modest downward pressure on China's currency.
"The Fed's rate hike, whenever it happens, will likely add depreciation pressure for the yuan, but with the help of foreign exchange controls and intervention, I believe China will and can keep the yuan at or stronger than 6.5 this year," UBS economist Wang Tao wrote in a recent note. She forecasts a modest devaluation of 3 to 5 per cent against the US dollar in 2016.
"Sharp yuan depreciation could [destabilise] domestic expectations, leading to more outflows and greater depreciation pressure; trigger large depreciations in other competitor economies' currencies, which in the end would limit the degree and export-related benefit of yuan depreciation," Wang said.
"The most important thing is not how much the yuan moves at this stage, but how much flexibility it has to decouple from the dollar and the Fed's monetary policy in the future," she added.
Heng Koon-how, a foreign exchange strategist with Credit Suisse private banking, said as long as the Fed raises interest rates gradually, and signals its intent, there should be "minimal impact" on the yuan and China's financial stability. However, some are doubtful. China will be able to defend its currency, despite a massive foreign currency reserve war chest.