Japan’s experience points to challenges for Chinese yuan

Current upward pressure on the US dollar-yuan exchange rate is essentially a function of greenback strength, not renminbi weakness
The real challenge will be if market sentiment starts to incorporate a bearish view on the yuan, as it has with the Japanese yen

Neal Kimberley

Published: 3:30am, 21 Sep 2022

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Broad US dollar strength on foreign exchanges continues to pose a challenge for the People’s Bank of China as it seeks to exercise some influence over the pace at which the yuan weakens against the greenback. But the real challenge will occur if market sentiment, currently primarily driven by US dollar bullishness, starts to incorporate a specifically bearish view on the yuan.

Japan’s currency experience this year illustrates the point. The yen has depreciated materially faster against the US dollar in 2022 than other major currencies, including the yuan. That is indicative of a market both enthused about the prospects for the dollar but which also harbours negative opinions about the value of the yen.

With the US Federal Reserve having left other major central banks behind with a succession of interest rate rises, cross-border yield differentials have come to favour the dollar, assisting its rise on foreign exchanges.

In stark contrast, the Bank of Japan has resolutely persisted with ultra-accommodative monetary policy, which has made the yen increasingly less attractive, compared to the dollar, with every passing Fed rate increase.

As it is, with US consumer price inflation still elevated, the Fed is set to raise US rates again this week, most likely by 0.75 basis points but with an outside chance of a 1 percentage-point increase.

The Bank of Japan will meet next week and is expected to leave policy settings unchanged. But, even if it were minded to be less ultra-accommodative, it would be unlikely to change market sentiment towards the dollar/yen, given the pace at which the Fed is hiking rates.

As for China, its own domestic economic circumstances currently require accommodative monetary policy. Consequently, as the Fed hikes US rates, but China does not, currency markets also seek to push up the value of the dollar against the yuan. That pressure is essentially a function of greenback strength, not renminbi weakness, for now.

However, there is another angle to consider. Historically, the success of Japanese exporters meant that Japan ran persistent trade surpluses.

As exporters needed to repatriate their overseas earnings, converting them into yen in the process, foreign exchanges always factored into their calculations that if Japan’s currency weakened, exporters would probably look to take advantage and, for example, sell their dollars for yen.

In short, when Japan was running a trade surplus, the attendant exporter demand for yen acted as a brake on the currency if it was slipping on the markets.

The problem is that Japan is now running a trade deficit, and one that hit a record high of 2.817 trillion yen (US$19.71 billion) last month. Imports leapt 49.9 per cent in August year on year, largely explained by the surge in US-dollar-denominated energy prices, more than offsetting the annualised 22.1 per cent increase in exports.

Is the falling Japanese yen cause for concern?

In consequence, currency markets have built into their calculations that Japan’s importers currently have more yen to sell, to generate the foreign currency needed to pay for those imports, than Japan’s exporters need to buy.

That lends itself to a weaker yen and merely exacerbates a situation already favouring the US dollar, adding to the pace at which the Japanese currency has slid on foreign exchanges.

Electronic boards display the yen’s rate against the US dollar at a foreign exchange brokerage in Tokyo on July 14. Photo: AFP

As for China, it continues to run a healthy monthly trade surplus, but export growth has slowed recently in the face of weaker external demand, while, over the longer term, continuing strains in relations with the West may also spill over into the trade arena.

Additionally, given that the export sector has been a pillar of support for a Chinese economy facing other headwinds, signs of a slowdown in export growth may undermine the value of the yuan on foreign exchanges.

China’s central bank has been seeking to limit the pace of yuan weakness that is currently largely a side-effect of US dollar strength, but the real challenge will be if the markets decide that China’s currency should be weaker on its own account.

Neal Kimberley is a commentator on macroeconomics and financial markets