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China’s Yuan Plummets Towards Record Low Amidst Battle with Bearish Forces

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The Offshore Yuan Weakens as China Signals Comfort with Depreciation

Bloomberg – The offshore yuan weakened toward its lowest on record against the dollar, as a cut to the daily reference rate for the managed currency stoked bets China is comfortable with a gradual depreciation.

China’s Currency Declines

  • China’s currency declined to about 7.36 per dollar in overseas trading.
  • This is beyond the psychologically important level of 7.35 and close to the weakest since the creation of the offshore yuan market in 2010.
  • The move came after the People’s Bank of China set its fixing at a two-month low on Friday.

Pressure on the Yuan

The PBOC is faced with a daunting task of maintaining the exchange rate and preventing capital outflows while keeping an independent monetary policy. However, China’s sluggish economy and dovish policy are heaping pressure on the yuan, especially as resilient US data and a high interest-rate differential there has traders favoring the dollar.

Such a trilemma is not new to Beijing, having occurred in the aftermath of the shock yuan devaluation in 2015 and during the height of the nation’s trade war with the US five years ago. Past experience shows policymakers tend to prioritize growth and allow a controlled depreciation eventually, as a weaker yuan makes China’s exports more competitive.

“The weaker fixing shows the PBOC is willing to accept a higher dollar-yuan rate as long as it is not an isolated case,” said Kiyong Seong, lead Asia macro strategist at Societe Generale SA. “The yuan’s future path largely depends on the general dollar movement which is hard to say at this juncture. But recent developments appear to support our year-end forecast of 7.60.”

Key Level

The drops in the yuan have been so sharp that the currency is perilously close to the weak end of its 2% trading band with the greenback. On Thursday, the onshore yuan slid to a 16-year low.

The decline in the offshore market on Friday was notable because the yuan went through the 7.35 level that was one China’s top leadership were playing close attention to last month, according to a Bloomberg report citing people familiar. The currency also weakened the most since mid-August against a basket of exchange rates, not just the dollar, a sign pessimism toward China was the biggest driver.

“Sentiment is also affected by the lack of real improvement in the economy and corporate profits,” said Gary Ng, a senior economist at Natixis in Hong Kong. “Until then, the yuan will likely face depreciation headwinds.”

China’s Response

China can still dig deep in its toolbox to punish yuan bears. The central bank can opt to engineer a cash crunch in Hong Kong to burn speculators shorting the currency, or make it more expensive for traders to initiate bearish trades with forwards.

Policymakers have already sought to slow the yuan’s decline by guiding state banks to sell dollars and boosting the supply of foreign exchange in the local market. Verbal support is also starting to appear, with a state-run newspaper saying in a front-page commentary on Friday that the yuan is only going through “intermittent depreciation” as the dollar index is strong.

Beijing has also announced a slew of other policy measures to help boost the economy, many targeted at the faltering property sector.

Still, while China’s support measures are gradually coming through, investors are not likely to see a rapid rebound in the currency, according to economists at Goldman Sachs Group Inc.

“Although yuan liquidity management could be sustainable and effective to push back against one-way depreciation expectations, current conditions still suggest weakening pressures on the yuan, especially as the dollar strengthens,” said a team including Xinquan Chen.

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