Chinese Yuan Two Year Low Against Dollar as Interest Rate Differential Widens and Economic Growth Shrivels

The Chinese Yuan, or Renminbi as it also known continues to crumble as the U.S. dollar marches back towards a 20-year high. The WSJ Dollar Index is now less than 1% off its 20-year high set on July 14. On Tuesday, the onshore yuan traded over 6.86 to the dollar at levels last seen in August 2020. The currency weakened past 6.88 in the offshore market, taking its year-to-date decline against the dollar to more than 8%. On Tuesday morning, the PBoC set the midpoint fix at more than 6.85 yuan to the dollar.

The dollar had rallied unrelentingly in the first half of the year, before softening in recent weeks as markets bet that the Federal Reserve would pivot to less-aggressive rate increases soon.


The surge in interest rates and the de-risking of the world is one factor but there are other particular influences. With regards to volatility in currency markets, these huge moves act like rubber bands when its crowded. The more stretched an exchange rate is, the bigger, faster and more painful the eventual correction. What is the catalyst? There is the obvious, a peace deal in Ukraine or a dovish Fed. However, it is usually something not expected.

The reality is the recovery from the pandemic is not yet complete and we have the specter of a US recession darkening the scene. The strong dollar adds to the pressure to tighten as weak currencies exacerbate imported inflation.

China

  • USD/CNY is the onshore yuan and is permitted to trade plus or minus 2% from the daily reference rate.
  • CNH is the offshore yuan. USD/CNH has no restrictions on its trading range.
  • A significantly stronger or weaker rate than expected is typically considered a signal from the PBOC.
  • The IMF lifted the yuan’s weighting in its Special Drawing Rights currency basket in May

Yuan weakness continued with its real estate crisis overhanging, dropping to its weakest level against the U.S. dollar in two years. It is likely to depreciate further as the country’s central bank moves to combat a slowing economy and a deep housing downturn.

On Tuesday, the yuan traded at more than 6.86 to the dollar in China’s tightly controlled onshore market, hitting levels last seen in August 2020. The currency weakened past 6.88 in the more freely traded offshore market, taking its year-to-date decline against the dollar to more than 8%.

The latest selloff in the yuan, or the renminbi accelerated as the U.S. dollar marched higher. Recent data releases also show China’s economy in rude health. Factory output, investment, consumer spending and youth employment numbers in July all pointed to broad economic weakness. China’s economy contracted by 2.6% in the April-to-June quarter from the first quarter of the year, official data released last month showed.

USDCNH Hits 2 Year Low

During July the PBOC cut the 5-year loan prime rate to 4.45% from 4.6% to boost the economy and cut short term rates further this past week. Beijing has warned against criticism of its dynamic zero-COVID policy. The zero-tolerance approach, which depends on strictest lockdowns and mass testing, has weighed heavily on the already slowing economy and raised the need for further policy easing.

On Aug. 19, the central bank also signaled its preference for a weaker yuan by setting its daily midpoint fix for onshore trading at more than 6.80 against the dollar. This was the first time it had crossed that level in 23 months. The PBOC allows the currency to trade within a daily range of 2% up or down against the dollar from its target level. The market is asking where the upper band is now?

Then on Tuesday morning, August 23, the PBoC set the midpoint at more than 6.85 yuan to the dollar. A weaker currency helps China’s exporters by making their goods cheaper. But it creates another headwind for foreign investors in stocks and bonds in mainland China by eroding their value. So far this year, international institutions have pulled more than $82 billion from yuan-denominated bonds, a record outflow for the asset class.

The forward margin between the Yuan and the USD has widened as the PBoC’s rate cuts have been made it less attractive to hold the yuan against the dollar because the U.S. Federal Reserve has gone in the opposite direction.

 April 28 – Bloomberg (Sofia Horta e Costa and Tania Chen): “When China’s tightly managed currency depreciates dramatically against the dollar, it can be hard to stop. More than six years after China’s shock 2015 devaluation roiled global markets and spurred an estimated $1 trillion in capital flight, the yuan is weakening at a similar pace. Onshore it’s lost nearly 4% in eight days, while the offshore rate is heading for its worst month relative to the greenback in history. Selling momentum is the strongest since the height of Donald Trump’s trade war in 2018.”

China Foreign Exchange Trading System

Asian currencies have had a dismal year. The Japanese Yen and South Korean won have been falling sharply lower in 2022. The won has weakened more than 8% this year, following an 8.6% drop in 2021, which was the fastest annual fall since 2008. The Won fell below the much talked about psychological threshold of 1,300 per U.S. dollar for the first time in 13 years

China Foreign Exchange Trading System August 2022

The Fed’s tightening cycle has triggered a widespread selloff in Asian currencies this year, including more than 10% declines for the Japanese yen and the Korean won. China’s central bank last let the yuan depreciate past 7 to the dollar in August 2019, during the trade war between Beijing and Washington.

The yuan however has held up better against other currencies this year. China Foreign Exchange Trading System, an arm of the central bank, measures the performance of the currency against a basket of 24 currencies, including the dollar, yen and euro and lesser-traded currencies such as Polish zloty and Russian ruble the WSJ reported. That yuan index was roughly at the same level it was at the start of 2022, according to the most recent data published on Aug. 19.

John Maynard Keynes, 1920: “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction and does it in a manner which not one man in a million is able to diagnose.”

Also factor in that Asia is the epicenter of technology manufacturing – with the global “tech” Bubble in grave jeopardy. The confluence of China’s bursting Bubble, Japan’s foolhardy monetary policy gambit, and highly levered systems puts Asia today on a Collision Course with rapidly deteriorating macro and micro fundamentals. I’ll assume mounting hedge fund and derivative issues.

Yen weakness places Chinese manufactures at a competitive disadvantage, which has emboldened Beijing to play the currency devaluation card in an attempt to mitigate mounting economic woes and dumping of Chinese assets. Higher-yielding Chinese debt securities are losing their relative appeal (in a rising yield world), and now even the perceived stability of the Chinese currency is in question.

A slump of that to 150 may convince China to intervene in the currency market to protect its own flagging economy and it would be perfectly rational for it to do so, former Chief currency economist at Goldman Sachs Jim O’Neill said:

‘If the yen keeps weakening, China will see this as unfair competitive advantage so the parallels to the Asian Financial Crisis are perfectly obviously,’ ‘China would not want this devaluing of currencies to threaten their economy.’”

Sources: TC WSJ

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