How low can the yuan go? Signs from the Fed and China’s economy point to further declines against the US dollar
- Neal Kimberley says the Federal Reserve’s determination to raise rates and roll back quantitative easing means the dollar is unlikely to weaken
- When combined with weak Chinese economic data, especially concerning autos and homes, there is reason to anticipate further declines in the yuan
“Never bet against the Fed” is an old financial markets adage, but it remains relevant. The Federal Reserve is set to stick to its plans to keep raising US interest rates. Any next leg of yuan weakness versus the US dollar is as likely to be driven by US dollar strength as by investor concerns about China.
Reasons to have material qualms about the Chinese economy will persist but it might be broader US dollar strength that primarily drives a higher dollar-yuan exchange rate, not yuan weakness. US dollar strength, alongside existing renminbi frailty, would be a powerful combination.
Admittedly, last week’s US midterm election results produced a more complicated political scene in Washington but the Fed’s policy statement on Thursday said US “economic activity has been rising at a strong rate”. As US bank Wells Fargo wrote after the announcement, “there was little in [the US central bank’s] statement that would suggest any change from the expectation for further gradual rate hikes”.
The prospect of higher US interest rates and the Fed’s continuing attempts to shrink the size of its own balance sheet, as it unwinds prior bouts of quantitative easing, should provide a solid platform for further US dollar appreciation, even if there have been political changes on Capitol Hill.
In truth, although the Democrats gaining control of the House of Representatives might well spell legislative gridlock in Washington, markets could conclude that such a scenario might support US asset prices, and by extension lend the US dollar some support. With US economic data broadly robust, markets could yet decide that the probable political gridlock bodes well for US equities.
Nor should investors assume that political change inside the Beltway will help rein in President Donald Trump when it comes to US differences with China on trade. In fact, the opposite may occur. The Democrat majority in the House of Representatives may well back Trump on this issue. Trump’s manifesto in 2016, including his anti-China rhetoric, proved attractive to blue-collar voters who had traditionally backed the Democrats.
“The United States must take strong, smart and strategic action against China’s brazenly unfair trade policies,” Nancy Pelosi, leader of the Democrats in the House, said in March. That could again prompt investors to envisage a still lower yuan versus the US dollar, especially when those, who have reservations about the trajectory of China’s economy, can still point to an array of economic data to bolster their argument.
Export front-loading helps to explain the strength of recent China trade data even as the Trump administration has rolled out tariffs but, looking ahead, the value of Chinese export orders to the US signed at the Canton trade fair, China’s largest, which ended on November 4, fell by 30.3 per cent on the year.
Meanwhile within China, data on November 8 showed automobile sales had fallen for the fifth month in succession. As for the property market, soon-to-be-published research from Professor Gan Li, of Chengdu’s Southwestern University of Finance and Economics, will indicate some 22 per cent of China’s urban housing stock is unoccupied. “Should any crack emerge in the property market, the homes to be offloaded will hit China like a flood,” Gan said.
It should also be noted that, following indications from the China Banking and Insurance Regulatory Commission that it might set a target for banks to allocate at least 50 per cent of new corporate loans to private firms in three years, Chinese banking stock prices dropped, hardly suggestive of investor enthusiasm.
US bank Morgan Stanley argued on Friday that “generally, placing funds into private entities is a positive factor, but with Chinese banks' large balance sheets, investors fear the credit risk linked to this directive policy step”.
As the US bank feels that “within a leveraged environment, it is more difficult to stimulate the economy”, particularly when, as in China, that economy operates in a closed capital environment, “it is the banking sector’s balance sheet quality that matters for the effectiveness of monetary policy”. Consequently, “the higher the accumulated credit risk within bank balance sheets, the less likely it is that banks will transform rising base money into long-term assets”, Morgan Stanley argued.
Optics play a very real role in markets. The combination of a narrative that regards the US economy as a glass half full but China’s as half empty may prove persuasive to market participants. Another material move higher in the value of the US dollar versus the yuan could well be in the offing.
Neal Kimberley is a commentator on macroeconomics and financial markets