China’s pain threshold for a weak yuan facing a serious test from a strong dollar

With virtually every currency weakening against the dollar, Chinese policymakers must decide whether it is worth resisting the tightly managed yuan’s decline.

Hina’s currency is fast approaching a level that prompted authorities to end episodes of depreciation in 2020 and 2019, when the yuan approached 7.2 per dollar, or about 4 percent weaker than its current level. Strategists say it’s only a matter of time before the yuan falls above seven, a key line of defense for China’s central bank in recent years.

Where Beijing’s depreciation limit is remains unclear. However, the scale and intensity of the measures taken so far suggest that the focus is on the pace rather than the direction of the yuan’s moves. A surging dollar and uncertainty about the strength of Chinese exports are among the reasons for authorities to tolerate a weaker currency as long as it doesn’t cause financial or social instability ahead of a big Communist Party meeting next month.

“If the yuan went to 10 and the euro and yen were stable against the dollar, that would be a much more problematic issue,” said Jim O’Neill, senior adviser at Chatham House. “But if the dollar rises against all currencies due to Fed tightening, there’s not much China can do.”

While the yuan is down 8.5 percent against the greenback this year and is on track for a seventh straight month of declines, it has still outperformed some of its key regional peers. The won has fallen 5.7 percent this year, while the yen has depreciated nearly 13 percent against the Chinese currency.

Of course, there are many reasons for the yuan to weaken, namely divergent monetary policies across much of the world, interest rate differentials, capital outflows and China’s slowing economy. But additional losses could fuel speculation that authorities will unleash the currency – and spur traders to bet on further depreciation. Such one-way bets have long been rejected by the PBOC.

“That’s the challenge of having a managed currency – it gives a lot more of a signal as to what policymakers are doing or not doing,” said Viraj Patel, strategist at Vanda Research in London. “Too much weakness is often a red flag for foreign investors, as it suggests Chinese officials know something we don’t.”

China’s central bank has taken a number of measures to ease dollar-induced pressures, including setting a higher-than-expected benchmark interest rate for 13 straight days. It has also drastically reduced the amount of foreign currency that banks are required to hold in reserve.

None of these moves worked strong enough or stopped traders from expressing a more entrenched bearishness against the yuan. The rhetoric of policymakers also sounded less alarming: PBOC Deputy Governor Liu Guoqiang said last Monday the yuan’s depreciation against the dollar has been much less than that of other major currencies this year.

Fluctuations in both directions will be the norm in the short term, he added, while cautioning against betting at certain levels.

Some analysts say the yuan could weaken further. Bank of America forecasts the currency to end the year at seven per dollar, while Nomura Holdings Inc. sees it falling to 7.2.

“The spot level is driven by both domestic and external factors,” said Lemon Zhang, FX strategist at Barclays in Singapore. “Defending a certain level with headwinds from both could be costly.”

In fact, there is little sign of panic in the FX market right now. This will hold true as long as the yuan’s moves are consistent with economic fundamentals, according to Anders Faergemann, senior portfolio manager at PineBridge Investments in London. However, he warned that any delay in exiting China’s tough Covid-Zero policy or further deepening of the country’s housing crisis could easily throw the calm into chaos.

Policymakers have enough ammunition stockpiled to manage the currency, including further easing banks’ foreign exchange reserve requirements or stepping up bill issuance to reduce the yuan’s liquidity. They also have more aggressive measures at their disposal, such as adding a risk premium to currency futures, which would discourage speculators by increasing the cost of dollar funding.

“If the yuan weakens beyond 8.5, policymakers would have to answer some serious questions,” Faergemann said.

https://www.independent.ie/business/world/chinas-threshold-on-pain-for-a-weak-yuan-facing-a-serious-test-from-strong-dollar-41977321.html China’s pain threshold for a weak yuan facing a serious test from a strong dollar

Fry Electronics Team

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