The Chinese yuan has been on a weakening path over the past three months, testing its weak point against the US dollar at 7.3 back in 2022.
This is a result of a sluggish macro recovery in China and widening interest rate differentials with the US, pushing the yuan to 7.18 per dollar. The sluggish growth prompted the People's Bank of China (PBOC) to cut the reverse repo rate by 10 basis points to 1.9% on June 13.
This was followed by two more cuts on key lending rates on June 19, indicating the beginning of a monetary easing cycle with a stimulus package to come.
Meanwhile, the US Federal Reserve remains hawkish, indicating one or two further potential hikes as inflation remains sticky.
It's against this backdrop that AsianInvestor collected views from the market on the outlook for the yuan over the next three to six months to find out how weak it could get and what it means for investors.
The following responses have been edited for clarity and brevity.
Isaac Meng, portfolio manager, Asia ex-Japan fixed income
Manulife Investment Management
CNY is expected to be trading moderately weaker over the next 3-6 months as the CNY/USD interest rate differential, or carry, has been widening and currently sits around -3.40%, based on the difference between China and US 1-year interest rate swap rates.
The main drivers for the trend include China’s monetary easing, a hawkish Fed, and China’s balance of payments surplus facing a cyclical headwind given weakening global export demand and rising services (and travel-related) deficit following the reopening of international travel.
Based on the interest rates difference, fair value for CNY is estimated to be around 7.20 over the next 3-6 months.
Key upside risks for the CNY include a stronger Chinese policy stimulus response that can regenerate momentum in the economic recovery and boost capital inflows. Peaking US rates with the US Federal Reserve ending hikes could result from weakening US growth, peaking inflation, or renewed US banking sector stress.
In the medium term, the Chinese manufacturing sector is under disinflationary pressure compared with G7 economies which face elevated inflation. Therefore, CNY’s valuation should be well supported by China’s competitive manufacturing sector as trade surpluses remain strong. The currency should also benefit from greater trade and financing demand between China and “Global South” countries.
Sven Schubert, senior investment strategist
Vontobel Asset Management
Our quantitative FX overlay model signals short-term USD/CNY upside due to diverging monetary policy trends.
As we believe that the Fed is close to the end of the tightening cycle, the US effect on the yuan is likely to fade in the near term. But monetary easing in China may have additional legs due to weak credit data in May and our business cycle model predicts a slowing near-term domestic growth momentum and slowing external demand for Chinese goods from developed markets. However, the longer-term prospects for the yuan have improved.
For the first time since the great financial crisis, our valuation indicator signals significant appreciation potential for the yuan against USD. Currently, our preferred valuation measure based on purchasing power indicates a fair value of USD/CNY of 6.00.
The convergence towards the fair value may gain traction in 2024 as we expect the Fed to ease monetary policy leading to a re-tightening of yield spreads between China and the US.
At that time the impact of recent ease of monetary policy and regulation should translate into a more sustainable Chinese growth recovery. Our business cycle model does currently favour emerging market assets due to stronger growth momentum and loose monetary policy conditions in China.
In particular, debt instruments (local and hard currency) seem attractive as they are still trading at distressed levels and the running yield is trading above longer-term averages. The outlook for a weaker dollar in 2024 and CNY value are, as well, an argument for emerging market local debt due to currency correlations.
Carol Lye, associate portfolio manager and senior research analyst
Brandywine Global
While there is some scope for the RMB to weaken near term, valuation across different valuation metrics suggests the RMB is now somewhat undervalued. In addition, Investor positioning on the RMB is quite bearish.
Therefore, the risk reward is increasingly tilting in favor of fading RMB weakness. This is especially so given the risk of further stimulus from the Chinese government, when the Politburo meets in July to stabilise growth.
In addition, US yields have already repriced upwards limiting the scope for further widening in US-China interest rate differentials.
Edmund Goh, head of China fixed income
abrdn
On a six-month horizon, we are mildly bullish on RMB against USD. The underperformance suffered by RMB in recent weeks seems outsized. Whilst the market has rightfully priced China’s poor economic performance this year, they might hold an overly hawkish view on a US rate hike trajectory and be too sceptical of the outlook of US-China relations.
We expect further rate cuts from China, but we are unlikely to see anything too aggressive. PBOC’s small 10 basis points MLF (medium-term lending facility) cut suggests that they are still in a quandary – their desire to stimulate the economy is circumscribed by their unwavering commitment to rein in property sector leverage and local governments’ debts. Balance of payment in China remains solid with strong FX reserves accumulated in the banking system, PBOC would likely intervene if RMB continues to weaken against the basket currencies at this pace.
On the US market, we think the Fed might only deliver one, instead of two, rate hikes this year and we expect the US economy to fall into recession early next year with their tightening measures bringing down inflation but increasing unemployment in the second half of this year. This would dampen the USD strength we’ve seen this year.
There’s also a consensus belief that China and the US cannot escape the Thucydides Trap. We think the chances of both governments backing down are higher than the street thinks. There is plenty of posturing from both sides, which we believe is part of their statecraft on foreign policy. Both countries would know that the best possible outcome of a war is a Pyrrhic victory that benefits nobody.
Christiaan Tuntono, senior economist, Asia Pacific
Allianz Global Investors
We remain cautious about the outlook of the Chinese Yuan over the next three to six months. This stems from our expectation of China’s narrowing current account surplus; weakening FDI (foreign direct investment) inflows and uncertain portfolio inflows; and still widening interest rate differential with the USD. USD/CNY may rise towards its 2022’s height at 7.3 if no change on the above is seen in the near term.
On the external accounts, we expect China’s current account surplus to narrow to 1.3% of GDP in 2023. Weakening global demand is expected to slow down China’s export growth this year, while recovering domestic demand upon the country’s exit from zero-Covid Policy are likely to revive import demand. In particular, rising Chinese outbound tourism is expected to raise Chinese service imports, while the delay in China’s border reopening and visa approvals are likely to slow down the inflows from inbound tourism.
On the financial account, we expect China’s FDI inflows to remain pressured amidst weakening global export demand and rising competition from neighboring economies. The reopening of the Indian and ASEAN manufacturing bases has been progressively luring away FDI flows from China.
On the rates side, increased US and developed market bond yields are also expected to weaken bond portfolio inflows into China, while equity portfolio inflows remain constrained by weak global sentiment on the Chinese markets.
Marcella Chow, global market strategist
JP Morgan Asset Management
We remain neutral on CNY and continue to believe that the outlook would still be primarily driven by the USD trajectory, given that the CNY is managed against a basket of currencies.
The still negative US-China interest rate differential will likely continue to weigh on CNY inflows over the short term.
Having said that, given China’s positive economic growth differential compared to developed economies with recession concerns in both the US and Europe, the current account in China will likely remain in surplus with increasing capital inflows. The CNY, therefore, will probably enter another medium-term appreciation cycle.
Even so, Chinese policymakers may not want to see an excessively sharp CNY appreciation before the economy is on a stronger and firmer footing, amid recent weaker-than-expected Chinese macro data.
Even though the prospects of a weaker broad USD in the medium term should keep the CNY relatively well-supported, the CNY appreciation will likely only be gradual.
Shao Yuting, macro strategist
State Street Global Markets
While the market awaits China’s announcement of the stimulus package, the divergence of policy path, negative carry and capital outflows could propel USD/CNY to stay elevated in the near term. The lack of strong pushback in PBOC fixings so far also signalled more tolerance for USD/CNY uptrend as yuan weakness aids external demand for Chinese exports.
Looking ahead, domestic consumption recovery remains the key while the trajectory of CNY will largely depend on the details of the stimulus package and how effective it will be in boosting recovery in the real economy. For investors, more forceful policy support as well as easing tension on geopolitical front following US Secretary of State Antony Blinken’s visit could alleviate weak sentiment and lead to a reversal in the capital exodus we’ve seen in recent years.
Freddy Wong, head of Asia Pacific
Invesco Fixed Income
We are neutral on the RMB currency. Although the USD/RMB exchange rate has been led higher recently by US dollar strength, weaker Chinese economic data and expected further easing from Chinese policymakers, we nonetheless see China’s solid external sector fundamentals as support for RMB performance in the medium term.
The PBOC’s statement in May also shows the central bank’s commitment to curbing one-way speculative moves of the currency. From a seasonality perspective, corporate dividend payments in the next two months could increase corporate demand for USD, whereas exporters’ dollar supply could provide some mitigating effect.
Stephen Chiu, chief Asia FX and rates strategist
Bloomberg Intelligence
Both onshore and offshore yuan may remain under pressure against the US dollar and a basket of trading partner currencies (the CFETS basket) at least until the late third quarter, before recovering and ending the year firmer.
On yuan, the market has finally woken up to China’s unbalanced and feeble recovery upon border reopening, so near-term sentiment would remain yuan negative. Seasonal dividend outflows could also pressure the yuan until August at least, with structural drivers like a peaking trade surplus and rising tourism outflows also likely to suppress the yuan further.
On the dollar side, the Fed may not be done hiking rates and with China even starting cutting rates again, rate differentials and hence carry allure would work against the yuan.
That said, once China’s monetary and fiscal stimulus channel through and economic data starts to outperform the increasingly bearish market consensus, then sentiment should work in the yuan’s favor.
Furthermore, once the Fed’s policy rate path is appropriately re-priced and the timing of the next Fed cut is more realistic, then the subsequent broad dollar selloff could point to lower dollar-yuan rates. Valuation also works in favor of the yuan as our model suggests a fair value near 6.6350. Dollar-yuan spot may have to rise toward the 7.2-7.3 range in the third quarter before ending the year closer to 6.7.
Chen Dong, head of Asia macroeconomic research
Pictet Wealth Management
Given the policy divergence between China and the US, we expect the renminbi to remain weak against the dollar in the very near term, possibly to test the previous low of about 7.35.
However, we are not expecting the weakness to stay too long or to lead to further significant depreciations. This is mainly due to two reasons. Firstly, the PBOC has long stated that it aims for a basically stable renminbi, with a proven ability to stabilise CNY if one-way volatility is too strong. Secondly, we think that a significant CNY depreciation would not be coherent with China’s desire to internationalise the RMB. Our current 3-month forecast and 6-month forecast stands at 7.10 and 6.95 respectively.
