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A man walks past the large screen showing stock and currency exchange data in Shanghai on September 29. The yuan hit a record low against the US dollar on September 28, the weakest since the global crisis in 2008. The central bank is taking steps to rein in yuan weakness. Photo: EPA-EFE
Opinion
Macroscope
by Neal Kimberley
Macroscope
by Neal Kimberley

As China’s central bank brings out the big guns, the tide is turning in favour of the yuan

  • Just as the pound plunged on the weak UK mini-budget, the yuan narrative is changing as Chinese authorities signal firm support for the economy and the yuan
  • It’s a matter of time before China ends its zero-Covid policy. Once traders sense yuan weakness is running its course, there could be an avalanche of dollar selling
The Chinese yuan has fallen against the US dollar this year and the move derives in large part from the strength of the US currency. But this doesn’t mean that further weakening is inevitable.

Indeed, the tide may be turning in the yuan’s favour as the narrative shifts.

This year has seen the dollar broadly strengthening, and this is largely traceable to the US Federal Reserve tightening monetary policy at a faster pace than other major central banks, in its attempts to tackle elevated US consumer price inflation.

Nor is the Fed likely to stop raising its interest rates just yet, unless – and this is not an immaterial risk – the pace at which it has been tightening monetary policy results in financial instability at home or, where this might adversely affect wider US interests, abroad.

As it is, with the US consumer price index still “unacceptably high”, Cleveland Fed chief Loretta Mester argued last week that “when there is uncertainty, it can be better for policymakers to act more aggressively because aggressive and pre-emptive action can prevent the worst-case outcomes from actually coming about”.

US Federal Reserve Board chairman Jerome Powell speaks at a news conference in Washington on September 21. The Fed said more rate increases are coming as it battles soaring prices. Photo: AFP

Elsewhere, like the United States, Britain too has been tightening monetary policy but the Bank of England, often referred to by traders as the Old Lady, has been raising its rates in smaller increments than the Fed.

Like many other currencies, the British pound has headed lower against the dollar.

The Bank of England clearly felt it had good reasons to act as it has, but adopting that position was hardly going to support the sterling and, as the old City of London foreign exchange mantra goes, the pound goes up by the staircase but down by the lift-shaft.

Well, sterling fell down the lift-shaft early last week, the pound’s decline turning into a rout as foreign exchanges fully digested a changed narrative, concluding that the implications of a financial statement from the UK’s new chancellor, Kwasi Kwarteng, was rather too full of what appeared to be unfunded tax cut pledges.

UK budget debacle could turn the tide against Truss and the Tories

Monday’s U-turn by Kwarteng on one proposal in his “mini-budget” is unlikely to shift market views about the overall package as, while it was politically significant, that U-turn was less financially consequential.
Though it had rebounded by the end of last week, sterling first hit an all-time low against the dollar, with market jitters cascading over into such a precipitate sell-off of UK government bonds that the Old Lady felt obliged to step in to head off what it deemed to be a “material risk” to UK financial stability.

Those tumultuous moves were not the result of feckless behaviour by out-of-control forex and gilt market participants, but were rational, if dramatic, market responses to new information.

Collective market rationality also applies to the prospects for the yuan and here too, the narrative is evolving, but this time, arguably in the renminbi’s favour.

Those who expect further marked renminbi weakness will certainly point to the challenges facing China’s economy, not least the impact of Beijing’s continued adherence to its zero-Covid policy, challenges that steady-to-accommodative Chinese monetary policy settings help to alleviate, while simultaneously referencing the Fed’s commitment to keep on raising US interest rates.

But with China’s zero-Covid stance, it’s surely not a matter of whether that policy is phased out, but when.

Meantime, as Premier Li Keqiang said last week, “in view of the prominent contradiction of weak demand” Beijing “will find ways to expand effective investment and promote consumption”. Zero-Covid policy or no zero-Covid policy, measures to bolster China’s economy are coming.

There is little to fear if China’s yuan depreciation is properly managed

If that puts a crimp in the rationale for further China-derived yuan weakness, then it’s also worth bearing in mind that information, available to the currency markets, clearly shows Beijing has precious little interest in seeing the renminbi fall further.

The currency markets know full well that the People’s Bank of China has been setting firmer-than-expected midpoint guidance rates and cutting banks’ foreign exchange reserve requirement ratios. The foreign exchanges have heard loud and clear the Chinese central bank’s verbal warnings against currency speculation and will be aware that it has reportedly been asking state-owned banks to ensure their offshore branches would be in a position to sell dollars for the yuan if needed.
All this is known. Nor, given the scale of China’s trade surpluses, can markets exclude the possibility that if Chinese exporters start to sense yuan weakness is running its course, there could be an avalanche of dollar selling against the renminbi in an attempt to lock in favourable conversion rates.

Information matters, and the narrative that markets have embraced to justify continuing yuan weakness is looking increasingly unpersuasive.

Neal Kimberley is a commentator on macroeconomics and financial markets

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