China’s tight grip on the yuan at home is creating an unintended side effect that will hamper its efforts to revitalize the economy – weakening the competitiveness of exporters.
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(Bloomberg) — China’s tight grip on the local yuan is having an unintended side effect that could hamper its efforts to revitalize the economy — weakening the competitiveness of exporters.
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In a potential dilemma for exporters, the yuan rose to its strongest level since October 2022 against a basket of trading partners’ exchange rates, including the won and the euro, according to Bloomberg’s CFETS index tracker. The outperformance came as the People’s Bank of China set a floor for the local yuan at 7.3 to the dollar since December amid a rebound in the US currency.
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China’s active currency defense bodes well for the country’s assets and beleaguered currencies in Asia, but further challenges for exporters – already facing US President-elect Donald Trump’s threats to raise tariffs – could lead to tepid earnings that could hamper any real recovery. Adopting a strict strategy in the Forex market by drawing a red line is also controversial, as artificial stability in the market may lead to bouts of volatility in the future.
Alvin T said: “One of the ways monetary policy easing works is through a weaker exchange rate,” said Tan, head of foreign exchange strategy at the Royal Bank of Canada in Singapore. “Therefore, if the exchange rate appreciates instead, it would mean less effective monetary policy easing, complicating China’s efforts to improve its economic outlook.”
The People’s Bank of China’s steady stabilization has helped push the local yuan’s historic two-week volatility to about 0.6% this week, the lowest level since July. But this may mask the problems ahead.
“There will be a significant spike in volatility once the level is broken,” said Mingzi Wu, a currency trader at StoneX Financial Pte Ltd.
He added that the yuan is still under downward pressure given the uncertainty in the Federal Reserve’s interest rate path, Trump’s tariff policy and ongoing risks from the Chinese economy.
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The decline in the Asian country’s benchmark yield, which fell below 1.6% for the first time ever, also led to a significant discount in interest rates in the United States. This has also contributed to pressure on the yuan as it undermines the attractiveness of Chinese assets.
In support of the yuan, the People’s Bank of China resorted to a so-called peg – which limits the currency to trade domestically within a 2% band on either side – at 7.1878 to the dollar on Friday. That was 1,324 points stronger than expected in the Bloomberg poll, the largest difference since July. State banks also sold dollars from time to time to prevent the yuan from falling beyond the 7.3 level.
The calm in China’s foreign exchange market and the authorities’ determination to maintain the currency’s red line will soon face tests after Trump returns later this month and acts on his pledge to raise tariffs on Chinese goods to 60%.
The market reading so far is less than optimistic. Chinese stocks posted their worst start in nearly a decade while government bonds rose. Meanwhile, the dollar remains strong, with its index ending 2024 with six straight days of gains.
Tan said the People’s Bank of China may loosen its grip on stabilization if the dollar continues to rise or if there is more clarity on Trump’s trade policy plans. “I think economic weakness should prompt the People’s Bank of China to allow further depreciation of foreign currencies.”
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