Will the yuan weaken further or bounce back next year? First, work out how strong the US dollar and euro are

The pace of Chinese economic growth is slowing and a 90-day timeout from the trade war with the United States doesn’t guarantee a peace treaty will be reached. Against such a backdrop, a case can certainly be made that the yuan, which has been on the back foot for much of 2018, will remain weak in 2019. Or could the renminbi regain its poise?

There are a number of issues to consider, not least that foreign exchange is a market of relative values. For example, if the yuan weakens versus the US dollar or the euro, the market is making as much of a judgment about the attractiveness of those other currencies as about the softness of the renminbi.

Those who see continued yuan weakness can point to the facts that the Chinese economy is slowing and the China-US trade war won’t easily be resolved.

“The economic cycle is downward, so we need relatively loose monetary conditions,” People’s Bank of China governor Yi Gang said on December 13, though he emphasised that while the Chinese central bank will be flexible in setting monetary policy, it has the resources to keep the yuan stable.

Recent data would support Yi’s view. Retail sales in China may have risen 8.1 per cent in November, year-on-year, but that figure, released last Friday by the National Bureau of Statistics, was below expectations for an 8.8 per cent increase, and was the smallest rise in 15 years. As for the 5.4 per cent year-on-year rise in industrial production in China in November, that was the slowest pace for almost three years.

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Rabobank is among those who see a weaker yuan in 2019. “Trade wars and slowing growth are clearly of particular concern in China,” the Dutch lender wrote. “Both of those factors argue for weakness in the CNY.” Although Rabobank doesn’t expect a dramatic fall in the yuan in the first quarter, “from that point onwards we expect significant selling pressure to build – if and when the trade war escalates”.

Bank of New York Mellon Corp argued that despite China’s repeated defence of the pivotal level of 7 yuan to the US dollar, “the prospect of Beijing allowing the [yuan] to weaken beyond this point cannot be dismissed so easily. After all, China is struggling to redress a stubborn and unrelenting economic slowdown … to which trade uncertainties have clearly contributed.”

But surely Beijing must respond to the economic situation. With that in mind, if it is true that the Chinese authorities are considering changes to the “Made in China 2025” agenda, to make it easier for overseas companies to enter the Chinese market, foreign capital flows into the country may rise.

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“China may see disinflationary pressures and rising unemployment, with potential knock-on effects on its social balance,” American bank Morgan Stanley wrote on December 13. “China’s administration has an interest in reducing the risk of such a challenging outcome. Hence, it may endorse long-term capital inflows.” An environment that is conducive to increased capital inflows might well produce a stronger yuan.

Additionally, the more capital inflows China attracts, the less capital there is available for investments elsewhere. This goes back to the idea that foreign exchange always reflects the appeal of different currencies to different market participants.

The euro is a case in point. Investors will have noticed that although European Central Bank president Mario Draghi said last week that risks to growth in the euro zone remain “broadly balanced,” he added that the balance of risks is moving to the downside.

Investors might wonder how attractive a proposition the euro is, when Draghi is making that observation even before the ECB has begun to hike interest rates and when its benchmark interest rate remains in negative territory, at minus 0.4 per cent.

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As for the US dollar, its allure could fade somewhat, as the sugar rush of President Donald Trump’s fiscal stimulus package starts to wear off, and markets weigh the prospects of a slowing in the pace of Federal Reserve rate increases.

Yes, the yuan had a rough ride in 2018, but for it to continue to depreciate in 2018, there have to be sound reasons both for its weakness and the strength of other currencies. That’s not such an easy case to make. Indeed, perhaps the risk is that far from weakening in 2019, the yuan strengthens.

Neal Kimberley is a commentator on macroeconomics and financial markets