MNI: Yuan To Weaken As Exports Soften-Advisors

The yuan is set to weaken against the dollar for the rest of the year, falling as low as 6.8 to the greenback, as exports soften and U.S. Treasury yields reduce the relative attractiveness of Chinese assets, foreign exchange traders and policy advisors told MNI.

Short-term support for USDCNY is located around 6.5-6.55, and the currency could fall to between 6.6-6.8 this year, they said, adding that the yuan could occasionally rally if there is broad dollar weakening or if stimulus boosts China’s slowing economy.

The dollar has gained 1.93% against the yuan this week, its biggest weekly advance since 2015, after the key level of 6.4 was breached on Wednesday when the central bank set CNY daily fixing far weaker than expected. At 16:30 Beijing time Friday, USDCNY closed at 6.4875, weakening by 375pips from the previous closing price , and the offshore USDCNH touched 6.5256, the weakest since July 2021. USDCNY continued to weaken later on Friday, passing 6.5. USDCNY continued to weaken later on Friday, passing 6.5.

The sharp depreciation signals the end of what may have been an over-extended yuan rally since mid-2020, and is line with the People’s Bank of China’s policy of allowing for more flexibility in the managed-float exchange rate, an advisor said. A more flexible yuan will allow the PBOC more room for monetary stimulus at a time when Covid lockdowns have hit domestic consumption and production as well as export orders, the advisor said.

The yuan’s retreat followed a strong-than-expected first quarter for the currency, during which it traded in a narrow range from 6.3-6.4 as a fall in the yield spread between Chinese 10-year government bonds and U.S. Treasuries to negative levels was outweighed by safe-haven inflows including funds from Russia after the invasion of Ukraine triggered sanctions on Moscow. (See MNI: Yuan Seen Benefitting From Russia Flows, To Weaken Later)

AHEAD OF FUNDAMENTALS

The currency however had got ahead of fundamentals, according to the advisor, noting that the yuan rallied by 0.8% against the greenback in February even though the dollar index strengthened slightly during the month. The PBOC should allow the yuan to weaken to around 6.6-6.7 to shore up the economy, the advisor said, but added that authorities needed to keep a close eye on capital outflows.

Foreign investors reduced Chinese bond holdings by CNY165 billion in February and March, a large amount by historical standards, according to data provider Wind.

The breach of the 6.4 level accelerated recent yuan selling which was already gaining momentum from dollar purchases to pay for oil imports, a trader at a big Chinese bank said. Dollar-buying by oil importers may now be peaking for the month, and could ease next week, the trader said.

Growing expectations for a weaker yuan may also reduce demand for the currency from Chinese companies, at a time when their export income is falling, the trader said.

Chinese banks sold a net of USD10.3 billion yuan on behalf of clients in March, the second lowest since May 2021 after this February’s USD2.6 billion, State Administration of Foreign Exchange data showed on Friday.

EXPORTS KEY DETERMINANT

Exports are a more powerful determinant of the yuan’s performance than the U.S.-China yield spread, a commercial bank FX analyst said, noting that foreign holdings of yuan assets are still relatively small and their movements subject to capital controls.

Factors which have been supportive of the yuan, including Russian inflows, are now fading, the analyst said. A 40% rally by the yuan against the yen over the past two years is also reducing China’s export competitiveness, he said, noting that Japan accounts for over 10% over the total trading volume in the Regional Comprehensive Economic Partnership trade agreement.

The PBOC started to guide the yuan lower in 2015 after CNYJPY rose above 20, the trader noted, though he added that more evidence was needed to determine the importance of the yen cross in the Chinese central bank’s forex calculations.

While some recent PBOC yuan fixings have been at weaker levels than expected, there is no sign of the reintroduction of the so-called “counter-cyclical factor” into the fixing formula, the trader said. The PBOC could still reintroduce the factor, used by the central bank to set the yuan’s central parity and whose precise composition has never been revealed, if significant one-way momentum builds in the exchange rate, the advisor said.