China to keep yuan currency from sliding below 7 to the US dollar as part of trade war deal, analysts said

  • US dollar may be reaching its peak given the outlook of fewer US rate hikes and weaker US growth next year, easing depreciation pressure on the Chinese yuan
  • The People’s Bank of China has plenty of ammunition to keep yuan from depreciating, if necessary
PUBLISHED : Monday, 24 December, 2018, 4:07pm
UPDATED : Monday, 24 December, 2018, 4:10pm

China will probably continue to prevent the yuan exchange rate from falling further as a prerequisite for a trade deal with the United States before the March 1 deadline, analysts said.

The People’s Bank of China (PBOC), the nation’s central bank, has successfully intervened in the market to keep the yuan stronger than seven to the US dollar and is expected to continue to do so.

The Trump administration has frequently warned China against using its exchange rate for competitive devaluation purposes.

Between late-March and October, the PBOC let the currency slump 12 per cent toward the key seven yuan to the dollar level amid the outbreak of the trade war with the United States, a strengthening of the US dollar and higher US interest rates.

But the yuan’s decline came to an abrupt halt and rebounded for the first time in eight months in November before trading in a range between 6.83 and 6.92 per US dollar in December, which analysts interpreted as a shift in PBOC policy to focus on stabilising the currency as part of the deal for the US holding off on further tariff increases.

Through capital controls and the daily yuan reference rate, the PBOC appears to be preventing the yuan from breaking the seven to the dollar level, which could adversely affect US-China trade talks and business confidence as well as a significantly increase capital outflow pressure, analysts said.

On Monday, the yuan was changing hands at 6.9111 against the US dollar, down 0.07 per cent from the previous session.

Earlier in the day, the PBOC set the midpoint of the yuan daily trading range at 6.9006 per dollar, down 0.26 per cent. Traders are allowed to trade the yuan within 2 per cent on either side of the midpoint.

China should defend yuan at 7 to the US dollar, adviser says

“Under a scenario of the ongoing US-China trade dispute and given the controversy over the exchange rate, there is not much room for yuan depreciation,” said Ding Wenjie, economist at CMB International Securities, predicting that the yuan would remain in a range between 6.70 and seven per dollar next year.

In October, US Treasury Secretary Steven Mnuchin has warned several times recently that the US would keep its eye on the yuan exchange rate to make sure that China does not use a weaker currency for economic advantage.

In any case, the technical factors supporting the yuan are improving: pressure from a higher US dollar is being scaled back because of expectations of slower US and global growth next year.

Traders are now “increasingly” predicting the US Federal Reserve will raise interest rates only once or twice next year, down from previous forecasts of about two to three times.

Becky Liu, head China macro Strategy at Standard Chartered Bank, said that her bank thinks the dollar’s value has peaked for now.

“This should take some pressure off the Chinese yuan as the dollar softens,” she said.

China’s central bank won’t be rushed into monetary changes

However, the yuan remains fragile as China’s economy faces headwinds in the coming year with deflationary pressure picking up and economic activity weakening, analysts said.

Last month, the consumer price index fell 0.3 per cent from October while the producer price index dropped 0.2 per cent – the first month-on-month fall in seven months – due to steep falls in the price of crude oil and coal, according to data released by the National Bureau of Statistics on Sunday.

Goldman Sachs said that net capital outflows picked up modestly to US$25 billion in November, with the domestic bond market showing a small outflow of around US$5 billion.

The US has a long list of complaints about Chinese trade practices, including a lack of intellectual property protection, forced technology transfer and widespread industrial subsidies, which may result in more heated disputes.

But China’s ability to defend the yuan remains strong, allowing the central bank to offset the downward pressure on the exchange rate as the trade talks continue, analysts said.

Over the weekend, the Ministry of Commerce said that China and the US held two rounds of trade talks via teleconference last week and achieved “new progress”.

Fed rate increase limits China’s central bank’s ability to aid economy

The talks included “deep exchanges” over issues such as the trade imbalance and intellectual property – two key US grievances – without elaborating further.

The talks follow a number of conciliatory gestures by China in the last several weeks, including rolling back additional tariffs on US car imports, placing big orders for US soybeans and de-emphasising the controversial “Made in China 2025” hi-tech industrial strategy.

“Exporters are still reluctant to convert USD-denominated proceeds into [yuan] owing to concerns of further [yuan] depreciation,” said Robin Xing at Morgan Stanley in a research note.

“Policymakers should still be able to … defend the currency against disruptive devaluation.”