Chinese yuan banknotes are seen in this photo illustration. Chinese exporters with US dollar holdings are likely to sell off their holdings if they sense investor sentiment turning against the greenback, thereby strengthening the yuan. Photo: Reuters
by Neal Kimberley
by Neal Kimberley

Why 2023 may be a good year for renminbi bulls

  • The US Federal Reserve will continue to raise interest rates, even if it crimps economic activity, while China is easing some Covid-19 measures
  • The prospect of the US economy slowing somewhat, while Chinese economic activity picks up, lends itself to a weaker greenback versus the yuan

Currency market trends don’t tend to end abruptly. The US dollar may still have room to strengthen versus currencies such as the Chinese yuan. But the tide could be turning and, in 2023, renminbi bulls may come up smiling.

More than 20 years ago, Stephen Li Jen and Fatih Yilmaz, both now of London-based Eurizon SLJ Capital, created the concept of the Dollar Smile framework. On one side of the Smile is US dollar strength derived from fear, in recognition that the greenback, as the global economy’s key reserve currency, is seen as an international safe haven in uncertain times.

On the other side of the Smile is US dollar strength predicated on investor greed. When the United States economy is outstripping other major economies, and expectations of higher US yields dominate investor thinking, the greenback strengthens on the foreign exchanges.

A semicircular arc that joins those two points and forms the Smile reflects how markets react when either the fear factor dissipates or investors start perceiving prospects for the US economy to be dimmer than for other economies.

In both cases, investors react by moving out of the greenback, pushing it weaker until the US dollar finally gets oversold at the base of the Smile and starts to rebound.

In reality, no currency market participant can ever know with absolute certainty when it is the top, or the bottom, in the US dollar. That can only be certain in hindsight.

Nevertheless, the art of the profitable trade is to correctly second-guess the investing crowd, before the crowd itself has worked out what it is going to do, and to act accordingly. And that’s where, at present, an interesting argument can be made in favour of positioning for the yuan to strengthen against the US dollar.

On the US side of the equation, the Federal Reserve will continue to hike interest rates, with markets fully pricing in an increase in December. Another hike will almost certainly follow in February. But the key word there is “pricing”. If the hikes are priced in, then they should already be reflected in the US dollar’s value.

Additionally, given how far and how fast the US central bank has been hiking interest rates in 2022, realistically speaking, the Fed is now closer to the end of the sequence of rate increases than it is to the beginning.

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That doesn’t mean that the Federal Reserve then starts cutting US interest rates, but rather that it just leaves them at a high level and lets them work their magic on US inflation, even if it puts a crimp in US economic activity. As Lael Brainard, vice-chair of the Fed, said in September, “the effect of the increased policy rate and pace of balance sheet shrinkage should put downward pressure on aggregate demand, particularly in interest-sensitive sectors like housing”.

Lower aggregate US demand implies a crimp in US economic activity and that could lead investors to look elsewhere.

China is edging towards a more flexible stance on Covid-19 containment, which will inevitably lead to a pickup in economic activity. Beijing will wish to support that economic bounce. The likelihood is that Chinese monetary policy settings will remain supportive.


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In the context of the aforementioned Dollar Smile framework, the prospect of the US economy slowing somewhat, while Chinese economic activity picks up, lends itself to a weaker greenback versus the yuan. Indeed, and coincidentally, a recent Eurizon SLJ research note, published on November 11 and co-authored by Jen, argues that macroeconomic circumstances may be beginning to favour the yuan over the greenback.

The potential of yuan-supportive currency market flows is apparent from an observation that Chinese exporters who, having seen the greenback trend higher versus the yuan in 2022 and being freer these days to manage their currency exposures, have retained more earnings in US dollars.

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If those same Chinese exporters now start to feel that investor sentiment is turning against the greenback, then they might start exchanging their retained greenbacks for yuan. After all, if expectations grow that the US dollar will be worth less tomorrow than it is today, it’s logical to sell the greenback sooner rather than later.

That pool of retained US dollars, held by Chinese exporters, could be hefty, with Jen making a conservative “guesstimate” that it could amount currently to more than US$1.3-1.5 trillion. That’s a lot of greenbacks that could be sold.

The US dollar performed well this year against the yuan, but 2023 may see the renminbi bounce back.

Neal Kimberley is a commentator on macroeconomics and financial markets