Wary of a strong yuan, China has reason to rue yen and euro weakness

While the US dollar is expected to weaken against the renminbi, its surprising strength against the euro and yen – the result of the Fed’s dovish turn and US Treasuries’ attractiveness viz-à-viz euro-zone and Japanese government papers – is bad news for Beijing

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Given Washington’s preoccupation with the US dollar/yuan exchange rate, realpolitik may dictate that a settlement of the US-China trade war will incorporate some subsequent renminbi appreciation versus the greenback. Photo: Reuters

Published: 1:00pm, 2 Apr 2019Updated: 10:27pm, 2 Apr 2019

The renminbi might be in for a further period of broad strength but that will be driven as much by the unattractiveness of other currencies as by any inherent allure. Other currencies – though perhaps not the US dollar – just don’t look that appealing.

Given Washington’s preoccupation with the US dollar/yuan exchange rate, realpolitik may dictate that a settlement of the US-China trade war will incorporate some subsequent renminbi appreciation versus the greenback. But if that was accompanied by broader US dollar weakness versus other major currencies, such an outcome may not be very unpalatable to Beijing.

The problem is that broader US dollar weakness might not occur. China could be faced with a stronger yuan against the US dollar but also see the renminbi rising further against other major currencies such as the euro and the Japanese yen.

On the face of it, somewhat less robust US economic data and a more dovish tone from the Federal Reserve might suggest that the greenback would now depreciate more broadly, given that it previously strengthened appreciably on a diet of Donald-Trump-initiated tax cuts and US central bank policy tightening.

But that might be to misread the situation. Take the US Treasury market for example. The Fed has pursued a course of interest rate hikes that have helped fuel higher US Treasury yields and lower prices. With the Fed now apparently minded to hold off from further rate hikes for the imminent future, and the bond market starting to price in the possibility of a rate cut, US Treasury yields have come off and bond prices have edged higher.

With the Fed now holding off from further rate hikes for the imminent future, and the bond market starting to price in the possibility of a rate cut, US Treasury yields have come off and bond prices have edged higher. Photo: Reuters

“To a bond manager, expected capital gains, not just yield differentials, are important factors driving bond allocations,” wrote Stephen Li Jen and Joana Freire of London-based Eurizon SLJ Capital on March 27. “High and falling yields put US bonds in their ‘sweet spot’, whereas high but rising yields, prior to the Fed’s policy pivots, made it less compelling for foreigners to buy US bonds.”