China’s Currency Proves a Surprise Oasis of Calm
Despite recent turmoil in financial markets, the Chinese yuan has been surprisingly stable, as trade talks between Beijing and Washington continue and other pressures eased.
The yuan has both been less choppy and strengthened against the dollar. It is now close to its strongest in 3 1/2 months, at 6.84 per dollar, despite sharp movements in global markets.
Some factors have moved in its favor. Compared with longer-dated U.S. bonds, yields on their Chinese equivalents are now more attractive, after a rally in U.S. Treasurys. Such interest-rate differences often drive currencies. The gap had narrowed through most of 2018, pressuring the yuan.
Fresh trade talks between Beijing and Washington have also bolstered the currency.
Market pricing also suggests investors are less convinced Beijing could let the yuan weaken beyond 7 per dollar, a level that could trigger self-reinforcing panic and capital flight. One-year forward contracts no longer imply any depreciation by the end of 2019.
Risk-reversals, which measure the difference in price between bullish and bearish bets on the yuan, have also fallen. That indicates declining demand for bets against the currency.
It is not clear whether the stability has been engineered by China. The People’s Bank of China didn’t seem to sell much of its foreign-exchange reserves in December, which rose just $11 billion to $3.073 trillion. Selling those securities is one line of defense against currency depreciation.
But the central bank has been known to use state-owned banks to intervene in forwards and other derivatives markets to support the yuan. And some analysts believe it will try to prevent the yuan from weakening beyond 7 to the dollar, at least during the current trade negotiations
Analysts at HSBC no longer expect the yuan to end 2019 above 7 to the dollar, having revised their forecast to 6.95 from 7.1.
“Heightened trade tensions are distracting the market,” said HSBC’s currency strategists in their annual outlook for the foreign-exchange market. “In our view, when confidence in China improves, there should be large foreign inflows into China’s equities and bonds.”
Not everyone agrees with the rosier outlook implied by forwards and other derivative markets. Analysts at UBS Wealth Management expect the currency to depreciate steadily through 2019, reaching 7.3 to the dollar by the end of the year on continued trade frictions and a weakening Chinese economy.
Source: Dow Jones