China: The Ongoing Depreciation In Yuan May Persist – Analysis

One week after the People’s Bank of China (PBoC) announced the use of its currency management toolbox, the onshore Chinese yuan or Chinese renminbi (CNY) to U.S. dollar (USD) exchange rate fell below 7.32, hitting a new low since 2008, and the offshore yuan also dropped below 7.34.

On September 7, the central parity rate of the Chinese yuan against the U.S. dollar was set at 7.1986, appreciating 17 basis points (BP) compared to the previous day’s rate of 7.3084, marking a difference of 1098 BP from the previous day’s closing rate. On the same day, after the market opened, the onshore yuan quickly experienced depreciation against the USD, surpassing 7.32, and closing at 7.3279. This exceeded the rate of 7.3275 seen in November 2022 and marked a new low since early 2008. Similarly, the offshore RMB to USD exchange rate depreciated on the same day, with intraday fluctuations around 7.33. During overnight trading, it briefly rose to 7.3450, approaching the new low of 7.3490 seen since late 2022.

The pressure for the recent depreciation of the yuan is rather strong. Looking at external factors, the current strong surge in the USD index over the past week is a significant reason. As of September 7, during the New York trading session, the USD index was at 104.96. While a strong USD naturally leads to relative weakness in the Chinese yuan, a series of macroeconomic factors are behind the strength of the USD.

From the latest U.S. economic data, the overall performance of the American economy appears strong, highlighting its resilience. On September 6, data released by the U.S. showed that the pace of expansion in the U.S. services sector in August exceeded expectations, with the services price index also rising further. This data intensifies concerns that inflation will remain in the short term and may prompt the Federal Reserve to maintain a hawkish stance, which in turn would strengthen the USD. The Institute for Supply Management’s (ISM) services index for August rose to a six-month high due to an increase in new orders and hiring. Furthermore, due to the robust U.S. job market, unemployment increased slightly from 228,000 to 235,000, which is the lowest level since February of this year.

It is worth noting that this rebound in the USD index reflects the emerging ruptures in the global economy. Economic growth in Europe and China is slowing down, and the market expects emerging economies to cut interest rates. However, the U.S. economy is still accelerating. Speculation about the Fed maintaining high interest rates due to the strong economy has fueled the ongoing rise of the USD, marking one of the longest periods of dollar appreciation in recent years. Kit Juckes, Chief Global FX at Société Générale, stated that “right now, the US economy is so resilient and the European data are so soft, it’s a recipe for dollar-strength overshoot”.

From an internal perspective, the fundamental reason affecting the Chinese yuan is still the economic challenges facing China. Observing the evaluations of the markets, it is apparent that market pessimism about the Chinese economy is continuously increasing. China’s economic recovery in the first half of this year has been far from expectations, and a key reason is the lack of confidence in the domestic market, where such a sentiment has spread from the domestic market to the international market. Some foreign investment and commercial banks, as well as rating agencies, have lowered their growth expectations for the Chinese economy after observing its performance this year. Despite Premier Li Keqiang’s statement at the ASEAN summit that China is expected to achieve a 5% economic growth target this year, market institutions clearly lack confidence. Crucially, once widespread market expectations are formed, investors in both the capital and industrial investment markets tend to adopt similar strategies, resulting in a kind of one-sided investment operation.

In the face of this established market trend, relying solely on a few policy adjustments would be ineffective. In other words, given the prevailing market sentiment of bearishness toward China’s economy and the yuan’s depreciation, the PBoC’s exchange rate control and intervention policies are unlikely to have the desired effect.

Amid the recent pressure on the Chinese currency exchange rate, the PBoC has already taken a series of actions. For instance, the central bank has twice employed exchange rate management tools. On July 20, the PBoC and the State Administration of Foreign Exchange (SAFE) decided to raise the macro-prudential adjustment parameter for cross-border financing of enterprises and financial institutions from 1.25 to 1.5. This marked the second increase in this parameter in nearly a year. On September 1, the central bank announced that, in order to enhance the foreign exchange fund utilization capability of financial institutions, it would reduce the reserve requirement ratio for foreign exchange deposits of financial institutions by 2 percentage points, from the current 6% to 4%, starting from September 15th. This foreign exchange reserve ratio cut is the third such reduction since the establishment of the foreign exchange deposit reserve system in November 2004. The previous two reductions occurred during a period of rapid devaluation of the Chinese yuan in 2022.

Following the implementation of the foreign exchange reserve ratio cut announcement, the CNY-to-USD exchange rate saw a minor increase on the same day, stabilizing around 7.27, with the lowest point nearing 7.24, the lowest level in nearly three weeks. However, after the opening on September 4, the yuan failed to continue its appreciation and instead depreciated for several consecutive days, with a total decline of 0.8 percentage points over four days. As of September 7, the rate has remained above the 7.3 threshold for three consecutive days.

Looking at the issue of the Chinese yuan now, it seems that the situation is quite clear. However, discussions on the issue are often post facto analyses. What truly holds value is making foresighted predictions six months or even a year in advance. Generally, the earlier the prediction, the greater its value, and the stronger its guidance for market investments. There has been much controversy surrounding predictions on the exchange rate trend in this regard, even among economists at ANBOUND. But from an institutional viewpoint, we have maintained a bearish outlook on the yuan. In our view, making predictions about market trends is a question of analytical ability, judgment logic, and thought framework. With these factors, along with a solid grasp of dynamic information through continuous monitoring, one can accurately understand the exchange rate trend. Looking back over the past year or two, Kung Chan, the founder of ANBOUND, has already foreseen the depreciation of the Chinese currency which was eventually confirmed by the market.

Final analysis conclusion:

Regarding the future trend of the Chinese yuan, we believe that among the numerous complex influencing factors, two essential aspects remain pivotal: first, the economic fundamentals of China and the United States, and second, elements formed by a series of policies. The former affects investors’ assessments of market prospects, while the latter influences their judgments on geopolitical developments, subsequently impacting market confidence. Given the current circumstances, we opine that the trend of yuan depreciation has not reached its conclusion. If these two fundamental aspects continue to deteriorate, the depreciation trend may persist. As for whether the yuan will reach its bottom or rebound, it also hinges on the stability of these two aspects.