Dollar weakens as yuan gains ground in global markets

China’s yuan will likely continue to appreciate against the U.S. dollar, although further sustained appreciation will largely depend on the magnitude of interest rate cuts by the U.S. Federal Reserve as well as the recovery of the world’s second-largest economy, analysts said.

“The main driver for the yuan, along with other Asian currencies, will be the extension of the Fed’s rate-cutting cycle,” said Heng Koon How, head of markets strategy at UOB Group.

“We expect a possible gradual easing of monetary policy from the People’s Bank of China going forward, but the main driver will continue to be the Federal Reserve’s interest rate cuts, driving the recovery of Asian currencies amid the backdrop of a weakening US dollar.”

On Monday (2), the People’s Bank of China set the reference rate – around which the yuan can trade within a 2 percent band – at 7.1027 per dollar, which was its strongest level since May.

The yuan gained 1.9 percent against the U.S. dollar in August, the biggest monthly gain since November.

As US inflation continued to ease, it paved the way for a possible first rate cut by the US Federal Reserve since March 2022, weakening the outlook for the US dollar.

U.S. Federal Reserve Chairman Jerome Powell said late last month that “the time has come to adjust policy,” marking a reversal after 11 consecutive interest rate hikes from March 2022 through July last year.

And analysts expect there will be more room for China’s central bank to ease policy to provide support amid weak economic momentum reflected in last month’s manufacturing data.

On Saturday, China’s official manufacturing purchasing managers’ index (PMI) — a survey of sentiment among factory owners — fell to 49.1 in August, remaining in contraction for the fourth straight month.

“The overall rate gap between the US dollar and the Chinese yuan is likely to narrow, and I do not expect further depreciation of the yuan in the event of a rate cut by the People’s Bank of China following the improvement in sentiment towards the yuan,” said Ken Cheung, chief Asian currency strategist at Mizuho Bank.

Tommy Wu, senior China economist at Commerzbank, said the People’s Bank of China could use bond trading to reduce depreciation pressure it deems excessive.

The People’s Bank of China said on Friday it sold long-term bonds and bought short-term bonds, resulting in a net purchase of 100 billion yuan ($14 billion) of debt in August.

“The overall yuan exchange rate is likely to fluctuate in both directions and appreciate in a volatile manner,” Kaiyuan Securities said.

“That said, pressure on the yuan remains as long as China’s growth momentum remains weak and the property market remains a source of concern,” Wu added.

But if the U.S. dollar continues to weaken in the coming weeks, it could also prompt more Chinese exporters to sell the currency and convert their foreign currency earnings into yuan, which could support the Chinese currency, analysts said.

Macquarie Group estimated on Friday that Chinese exporters and multinationals have held more than $500 billion in foreign currencies since 2022.
A mass conversion to the yuan would be a major event, as it could significantly increase demand for the yuan in a short period of time.

However, analysts at Kaiyuan Securities believe such a scenario is unlikely due to weak domestic demand in China and uncertainty for Chinese exports, while interest rate differentials between the two countries are also likely to remain significant in the near term.

“As a result, this will curb the enthusiasm of related foreign trade enterprises to continue to settle their foreign exchange [em yuan],” Kaiyuan Securities said on Sunday.

“Therefore, the overall yuan exchange rate is likely to fluctuate in both directions and appreciate in a volatile manner.”

Via South China Morning Post