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Tighter US monetary policy could weaken China’s currency. Photo: AP

US tapering: China urged to make preparations for ‘spillover’ after Fed confirms tapering

  • The Federal Reserve said on Wednesday it would start unwinding its pandemic stimulus, which could weaken China’s currency
  • Although the decision was well telegraphed, analysts say China should be prepared to ‘counter’ unexpected consequences

China’s yuan appreciated slightly on Thursday, defying expectations it would weaken on imminent tapering from the US Federal Reserve, although Beijing has been warned to prepare for “possible spillover”.

Federal Reserve chair Jerome Powell announced on Wednesday asset purchases would be scaled back by US$15 billion a month. Some analysts predict the tapering to be finished by June next year and it is likely to be followed by rate hikes.
The US central bank’s move to unwind its massive pandemic stimulus is a key external uncertainty facing the world’s second largest economy, which could trigger capital outflows and weaken the Chinese currency.

“The Federal Open Market Committee (FOMC) statement is well in line with market expectations, and the financial market is overall stable,” said Wen Bin, chief analyst of China Minsheng Bank.

To counter possible spillover, China should maintain an independent monetary policy and make preparations with a more forward-looking approach
Wen Bin

“To counter possible spillover, China should maintain an independent monetary policy and make preparations with a more forward-looking approach.

“The Chinese central bank may use a combination of policy tools, including reverse repo and medium-term lending facilities, to ensure a reasonably ample market liquidity, and use structural policy tools to guide the support for the real economy.”

The People’s Bank of China set yuan midpoint at 6.3964 per US dollar on Thursday, stronger than the previous fixing of 6.4079. The onshore exchange rate traded stronger at 6.3958 in the spot market.

The US dollar index, which has a negative correlation with the value of the yuan, dropped 0.2 per cent in the two previous trading days to 94 points, as the market factored in Powell‘s announcement.

Zhou Hao, a senior emerging markets economist with Commerzbank, forecast the yuan to weaken to 6.6 per US dollar by year-end, as the taper unfolds.

“The pressure on the yuan will persist next year because the US may raise its interest rate and the Chinese economy still faces downward pressure,” he said.
Guan Tao, a former forex regulatory official and now chief economist at BOC International, said China should make contingency plans and deepen its tool kit to deal with abnormal fluctuations in the yuan exchange rate.

“When the forex market encounters extreme conditions, we should step in at an appropriate time to prevent one-way market expectations,” he wrote in an article on on Thursday.

China’s commodities market has been hard hit since the announcement, with the most  active crude oil futures contracts, delivered in December, falling 3.4 per cent to 510 yuan per tonne on Thursday. Rebar futures due to be delivered in January traded 3.3 per cent lower at 4,193 yuan per tonne.

Beijing, which imposes stringent capital controls, has called the impact of US tapering controllable in an effort to anchor market confidence, saying its flexible yuan exchange rate to absorb the external shocks while stepping up its crack down on underground banks.

Cheng Shi, chief economist of ICBC International, the investment bank arm of China’s largest state-owned bank, attributed market calmness to the Federal Reserve’s constant communication over its tapering path.

However, he warned the US central bank had obviously misjudged a series of indicators including economic growth, inflation and labour market conditions this year.

“Our review of the FOMC minutes in the past five years found the Fed actually didn’t endeavour to achieve the goals of inflation control or full employment,” he said in a research note.

[The Federal Reserve’s] misjudgments may pose dangers to either the American economy or global markets
Cheng Shi

“It seems not prudent during the radical macroeconomic changes, and also neglects the long-term impact of the coronavirus pandemic on supplies.

“Its misjudgments may pose dangers to either the American economy or global markets.”

US inflation has stayed above 5 per cent for five straight months, including 5.4 per cent in September.

China International Capital Corporation, a leading investment bank, also believes US inflation will last into the second half of next year, or even longer.

“The supply restraints, from chip shortages, port congestion and labour shortages, are not as easy to solve as what Powell described,” it said.

This article appeared in the South China Morning Post print edition as: Yuan holds ground despite US tapering move