YINAN, CHINA – DECEMBER 26, 2024: A worker counts RMB banknotes during a gathering to distribute annual dividends to members of an agricultural cooperative in Yinan County, east China’s Shandong Province, on Thursday, December 26, 2024.
Wang Yanbing | Publishing of the future | Getty Images
The Chinese yuan is expected to depreciate against the rising US dollar. The thornier question facing market watchers: How far and how fast could the currency slide?
The stakes are huge. The impact of the yuan’s pronounced weakness could not only reverberate around the world by reducing export competitiveness for countries that compete with China to sell goods and services to the world, but could also undermine efforts by Chinese authorities to accelerate growth in the world’s second-largest economy.
China’s offshore yuan has lost more than 3% since Donald Trump’s presidential election victory in early November as the outlook for monetary policy in the US and China diverged. The tightly controlled mainland yuan also retreated close 16-month minimum.
Many investors are not looking at China’s prospects. The country is struggling with a real estate crisis and tepid consumption. As market participants worry about deflation and banks struggle to increase demand for loans, there has been a flood of funds into government bondsbringing yields to record low levels.
In contrast, policymakers at the US Federal Reserve are now predicting fewer rate cuts than they did previously. Higher tariffs proposed by incoming US President Donald Trump, if implemented, could fuel inflation and further slow the Federal Reserve’s easing cycle, keeping interest rates, and consequently bond yields, were elevated for a longer time.
Yield on US 10 Year Treasury has been steadily rising since June and exceeded 4.7% this month, a level last seen in April. The US dollar indexwhich measures the dollar against six other currencies, rose to nearly a 26-month high.
Markets beat expectations for the number of interest rate cuts by the U.S. Federal Reserve this year, lowering rates by just one-quarter of a percent in 2025, according to on the CME FedWatch tool from Friday.
With the widening gap in yields between US debt and Chinese debt, investors have lifted the dollar and dragged the yuan lower.
‘Orderly rejection’
Market developments are testing the resolve of policymakers. While a weaker yuan should help improve the attractiveness of Chinese exports, authorities also want to avoid a sharp decline in the currency that could cause excessive volatility.
In an attempt to raise bond yields, the People’s Bank of China suspended the purchase of government bonds last week, citing excessive demand in the market as it increased issuing invoices in Hong Kong to stop the fall of the yuan.
The central bank has recently enhanced announcements to warn against speculating against the currency and signal that rising government bonds could undermine financial stability.
“We will resolutely prevent the risk of overshooting the exchange rate, ensuring that the yuan exchange rate generally remains stable at a reasonable, balanced level,” said PBOC Governor Pan Gongsheng last week.
It echoed the opinion in a separate last Tuesday’s press conference at which high-ranking officials he reiterated the moderately loose stance of monetary policy, at the same time emphasizing the importance of exchange rate stability.
“Such communication implied that the PBOC might prioritize exchange rate stability over easing monetary policy in the near term,” Goldman Sachs economists said in a note last week.
The central bank kept benchmark prime lending rates unchanged on Monday as it seeks to keep the currency stable.
Still, the offshore yuan could weaken to 8.5 to the U.S. dollar by the end of the year, said David Roche, strategist at Quantum Strategy, considering a scenario in which Trump would impose the promised 50%-60% tariffs on Chinese goods.
The currency last traded at 7.3357 against the US dollar on Monday.
“The Chinese authorities will try to make the yuan fall in an orderly fashion,” Roche said, warning that Beijing’s stimulus measures are “insufficient” to do more than stabilize the economy, as they have failed to address key issues such as weak demand and excessive household savings.
Yuan priority
Pan Gongsheng, Governor of the People’s Bank of China (PBOC), during the Asian Financial Forum in Hong Kong, China, on Monday, January 13, 2025.
Lam Yik | Bloomberg | Getty Images
The central bank is likely to refrain from sharply cutting interest rates in the near term, despite mounting pressure on domestic growth, said Helen Qiao, China and Asia economist at Bank of America, given the temporary policy priority of exchange rate stability.
She expected the central bank to continue to defend the currency with stricter capital controls and guidelines for the liquidity of financial institutions.
While the hawkish FED is limiting the PBOC’s room to cut interest rates, Beijing still has plenty of policy tools to prevent excessive currency movements, including verbal intervention, adjusting offshore liquidity through the issuance of bills and “attracting state-owned financial companies to directly buy CNH [offshore yuan]”, said Lynn Song, Chief Economist for China at LNG.
For the onshore market, the primary tool used by the PBOC to manage the currency was the daily reference rate — the onshore yuan was only allowed to trade within a 2% range of this reference rate. The central bank has been keeping the exchange rate guidelines since last year stronger than 7.20 to the dollardespite the rising dollar.
The mainland yuan was fixed at 7.1886 to the dollar on Mondaybut markets have been pushing it to the weaker side of the range, last trading at 7.3249.
The export in question
China’s economic activity has accelerated more than expected in the last quarter of 2024buoyed by strong exports as businesses are preloaded with shipments ahead of the tariff hike, but experts warn that the growth momentum could fade later this year when Trump’s tariff hikes take effect.
“Beijing doesn’t want to see the currency collapse before it knows what the situation is,” said Kamil Dimmich, portfolio manager at North of South Capital, alluding to uncertainty over the size and pace of tariff increases by the Trump administration.
Trump, who will take office on Monday, has promised universal tariffs of 10% to 20% on all imported goods and 60% or more on shipments from China, although some believed the tariffs would be phased in gradually.
“While tariff increases could be higher in Trade War 2.0, the room for yuan depreciation could be much smaller this time around,” said Larry Hu, chief China economist at Macquarie, as Beijing signaled its political inclination ” relatively stable” yuan.”
He predicted the offshore yuan would peak at 7.50 to the dollar in the third quarter of this year.
