China is facing a number of economic headwinds at the moment. It could be argued that the yuan should be weaker. Problems in the real estate sector remain, exemplified by the still-unresolved Evergrande debt crisis . Energy shortages have affected people’s lives and economic activity in many provinces. But first impressions may be deceptive. First, while property developer China Evergrande Group’s debt crisis rumbles on, it is now well and truly in the public domain. Markets have been aware of the situation for some time. If the foreign exchanges had collectively calculated that Evergrande’s woes, and indeed the wider issue of Beijing wishing to see a general reduction in leverage in China’s real estate sector, should materially weigh on the value of the renminbi, then that should have already been priced in. As it is, the currency markets cannot have failed to have noticed that some distressed debt investors , who were casting their eye over the Evergrande situation, have now decided the time is right to buy some of the beleaguered firm’s US dollar-denominated paper. Their reasoning is that the current price is materially lower than it will be once the restructuring is finalised. Clearly, although there is no guarantee of success for such investors, their bond-buying interest can help shape a broader narrative on China Evergrande Group that has been uniformly downbeat. In turn, this may have implications for currency markets, to the extent that the developer’s predicament could have been viewed as a negative for the yuan. Additionally, in an atmosphere where comparisons were being made between Evergrande and Lehman Brothers, it would have been hard for portfolio managers to make a case for buying the renminbi, even if those same investors might not have opted to sell the Chinese currency. In light of the changing narrative, however, the renminbi bulls that held back may now be more inclined to look through the Evergrande situation and rebuy the yuan. As the narrative around China Evergrande Group starts to look marginally less gloomy, it must undermine any case that included the firm’s struggles as a reason to sell the yuan. Any such shift in market psychology matters, especially as it’s not cheap to run short of the yuan versus the US dollar. Why the Fed’s monetary policy is setting up US dollar for a fall Interest rate differentials favour the renminbi. Currency traders rolling that position day-to-day in the forward market have to pay to play. That might be an acceptable cost if the rationale for holding the position remains solid but it becomes onerous if the reasoning behind the trade becomes less persuasive. In those circumstances, markets might well unwind the exposure, buying back the yuan and selling the US dollar. Yet, unwinding a long US dollar/short yuan position just gets a trader back to square one, with no open exposure to either currency. It doesn’t necessarily mean those same traders then move into a short dollar/long renminbi trade. That might require a further catalyst, a further tweak to the prevailing narrative, and it may come from a closer appraisal of the currency implications of China’s energy issues. China’s ‘common prosperity’ goal won’t mean Robin Hood-style redistribution Markets know that many provinces are having problems securing enough energy to supply all needs, and that this issue is not just restricted to China. Many other countries face energy shortfalls. But markets also know that Beijing will do everything it can to cover its energy needs ahead of the winter months and that such energy is generally priced in US dollars. It is to be hoped that energy demand and supply will reach an equilibrium at price levels that the global economy can afford. But while demand exceeds supply, prices will inevitably stay high or even rise further. A stronger yuan would act as an offset. Markets might rationally conclude that, for now, Beijing would be happier with a stronger yuan that could then buy more US dollar-denominated energy. Without overstressing the point, the yuan market pays close attention to what it thinks Beijing is seeking to achieve. In past months, it’s probably fair to say that the foreign exchange market felt China wanted the yuan to trade in a fairly tight range. But times change and the foreign exchanges will take into account Beijing’s awareness that yuan strength would help eat into China’s burgeoning US dollar-denominated energy bill. The narrative around the Chinese currency seems to be changing. The result may be a stronger yuan. Neal Kimberley is a commentator on macroeconomics and financial markets