Rise of the RMB

Warning from Wyoming

Powell speech heaps more pressure on yuan-dollar exchange rate


Fed chairman Jerome Powell

It wasn’t just Wall Street that was rattled by the warning from Jerome Powell last Friday that there could be pain ahead as the Fed tries to get inflation back under control.

The comments from the Federal Reserve boss were soon reverberating through the foreign exchange markets, where the yuan was already languishing at 20-month lows against the dollar.

Previous declines in its value against the dollar have stirred allegations that China was forcing its currency down deliberately in a bid to boost its exporters. But its latest slide isn’t something that policymakers want to encourage, most commentators agree, because of the potential side effects.

A weaker yuan brings the risk of a flood of capital outflows as investors sell yuan-denominated assets and move the proceeds offshore. It increases the dangers of importing inflation as well, as goods and services from overseas start to cost more in the depreciated currency.

Indeed China’s foreign exchange regulator was reported to be phoning around the leading banks to warn them against selling the yuan and buying the dollar, according to Reuters last week. The central bank has also been setting the daily reference rate around which the yuan is allowed to trade in the onshore market at stronger-than-expected levels in a bid to stiffen its position.

Domestic newspapers have rallied to the currency’s cause as well. The gap between China and US interest rates isn’t going to have the impact that many fear because the yuan is supported by China’s trade surplus, the Securities Times felt. The yuan is also proving much stronger compared to other currencies, Economic Daily reckoned, pointing out how it has been appreciating against the euro, the pound and the yen. Overseas investors have been net buyers of Chinese assets in August, so they must also see the yuan as offering value over the longer term, argued Xinhua. And Washington won’t be able to fix its inflationary woes, which will soon erode the appeal of US assets, the Global Times hoped.

None of that seemed to have much impact on the first morning of trading after Powell’s hawkish comments in Wyoming, however. Instead the yuan dipped again, breaching the 6.9 per dollar level despite another firmer fixing of the exchange rate that morning than most had anticipated.

For investors the focus was more firmly on the diverging paths of the two central banks. While the Fed is waging war on inflation – and signalling the potential for more interest rate rises ahead – the People’s Bank of China is more intent on mitigating a slowdown in the Chinese economy, including tactics like reductions in the key lending rates (see WiC596).

The PBoC was back in action on Tuesday, setting its reference rate for the yuan with the second strongest bias on record, or 249 pips stronger than the average estimate in a Bloomberg survey. But the currency stayed under pressure, moving towards the key seven per dollar level, which was last seen in July 2020.

Paul Mackel, global head of FX research at HSBC, forecast last week that the dollar-yuan exchange rate will trade into a higher range for the rest of 2022. But he also thinks the dollar is unlikely to repeat the full extent of the gains that it made earlier this year. Expectations about the different yields of the two currencies have narrowed, because of the way that the greenback has already strengthened so much in 2022. And it’s unlikely that China’s economy will perform as poorly as it did during the second quarter, with policymakers pushing forward with fiscal stimulus and monetary easing.

“We now see USD-RMB higher at 6.90 by end-2022 (previous forecast: 6.65) and at 6.95 by mid-2023 (previous forecast: 6.70),” Mackel predicts.

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