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Chinese Officials Are Letting Go, But Devaluation Is Not Likely

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Chinese Officials Are Letting Go, But Devaluation Is Not Likely

Key Points

  • The value of the Chinese yuan has dropped to its lowest point since November.
  • By making the midpoint for the onshore yuan weaker, Chinese officials have permitted the yuan to fall.
  • Additionally supporting reports have been those of the Chinese central bank purchasing bonds, which may be an indication of the beginning of quantitative easing.
  • It’s still possible that broader easing will wait until the Fed starts easing.
  • With trade tensions escalating, Chinese officials are unlikely to allow the yuan to drop much.
  • However, the USDCNH has moved to a higher trading zone, and the yuan’s direction is still leaning towards weakness.

China is facing more economic strain as the country’s property market struggles and its manufacturing sector fails to meet expectations. While most other central banks have been tightening policy, the central bank’s attitude has remained accommodating.

However, this year has seen no appreciable weakening of the yuan. Compared to the almost 10% decrease in the Japanese yen, the 7% decline in the Korean won, and the 5% decline in the Taiwanese dollar, the onshore yuan has declined by just over 2% against the USD year to date.

This results from the central bank’s consistent manipulation of the yuan through its daily fixes. Every day, the central bank establishes the onshore spot midpoint and permits trading within a tolerance of +/- 2%. Although it has traded above the band for most of this year, the offshore yuan (CNH) closely tracks the onshore yuan as well.

Chinese

With the USDCNY midpoint at 7.1192, today’s onshore spot midpoint fixing was the weakest since November. This could mean that to control the pressure of depreciation, the People’s Bank of China (PBoC) is prepared to allow the yuan to fall much more. Due to this, the yuan has fallen to its lowest points since November for both onshore and offshore.

The pressure is further increased by reports of quantitative easing, which raise the possibility that the PBoC may purchase bonds of its own. The governor of the People’s Bank of China, Pan Gongsheng, refuted the notion that this bond trading represents a type of enormous monetary easing, characterizing it as a tool for managing liquidity instead.

Since export limitations from the US and Europe are getting tighter, Chinese officials are probably going to be wary of any abrupt weakness or devaluation of the yuan to avoid being labeled as currency manipulators.

However, market players are set up to depreciate the value of the yuan at the first indication that China may increase its quantitative easing program or relax its controls over imports. The direction of the yuan is still evident, although the rate of depreciation will probably be monitored. The trading band for USD/CNH has probably moved higher for the time being.

USDCNY

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