Yuan’s Best Forecaster Says This Currency Slump Is Close to Over

(Bloomberg) -- After its worst quarter on record, the yuan may finally be headed for a break.

The People’s Bank of China will hit the brakes on depreciation to avoid sparking global volatility and exacerbating capital outflows, according to Svenska Handelsbanken, the currency’s top forecaster. The case for an end to yuan weakness is supported by its impending entry into the International Monetary Fund’s reserves basket in October as well as a dovish Federal Reserve spurring dollar declines, says JPMorgan Asset Management.

The yuan has posted Asia’s biggest decline this year on speculation policy makers were guiding depreciation against both the greenback and a trade-weighted gauge as they looked to boost exports and revive economic expansion. Things may finally be turning around, with data from gross domestic product to retail sales spurring optimism that growth will steady and that the monetary authority will refrain from aggressive easing.

“They will take a breather now and celebrate that they have managed to depreciate the yuan without creating too much noise and without creating too much capital outflows," said Bjarke Roed-Frederiksen, a Copenhagen-based economist at Handelsbanken, the most accurate yuan forecaster tracked by Bloomberg over the last four quarters.

There are already signs of the weakness abating. The yuan briefly erased its losses against the dollar last week, halting a five-week run of losses, before a late resurgence in the dollar. A Bloomberg replica of the 13-currency CFETS RMB Index advanced for the first time since May in the five days through July 15. The currency’s run of losses this time round has avoided sparking the sort of market panic seen in August and January, when yuan weakness roiled global markets and spurred speculative bets against the exchange rate.

This is because China’s central bank has improved its communication with markets, provided clarity on how it sets its daily reference rate and taken steps to prevent a downward spiral of depreciation and capital outflows. The PBOC also probably understands that it has pushed the envelope far enough for now, according to Roed-Frederiksen.

"I think they realized they probably shouldn’t move any further for the moment," he said, adding that the PBOC may opt for slight depreciation again in the fourth quarter to finish the year at 6.8 a dollar. "They are satisfied with what they have achieved for now and they are -- or at least should be -- afraid global investors’ focus will return and also that domestic investors will start worrying again about depreciation and thus increase capital outflows."

Capital Outflows

An estimated $1 trillion left China last year as the yuan’s abrupt devaluation in August prompted firms to repay their foreign debt and local investors to pour cash into overseas assets. As the yuan stabilized, monthly outflows slowed to an average $68.6 billion through May this year, compared with $113 billion in the second half of 2015. Foreign-exchange reserves unexpectedly increased in June, a sign outflows are slowing.

There are some fundamental reasons for the yuan to stabilize, according to Ji Mo, Hong Kong-based chief economist for Asia ex-Japan at Amundi SA. She estimates that the foreign-currency debt of Chinese companies has dropped to about $500 billion from $1.1 trillion at end-2015, reducing repayment pressures.

Speculation that authorities were curbing declines in the exchange rate resurfaced last week when the overnight yuan interbank rate in Hong Kong jumped to a five-month high. The yuan index’s gain last week indicates that the PBOC may have intervened to stem depreciation, said Zhou Hao, an economist at Commerzbank AG in Singapore.

Survey Estimates

The yuan rose 0.16 percent Tuesday, the most in more than a week, to trade at 6.6909 against the greenback, after weakening beyond 6.7 for the first time since November 2010 in the previous session as better-than-expected U.S. economic data buoyed the dollar. The Chinese currency will end the third quarter at 6.7 and the year at 6.795, according to median estimates in a Bloomberg survey of analysts conducted in the past week. The official CFETS index will drop slightly to 93.5 at year-end from 94.38 last Friday, the median of 13 estimates in the same survey showed.

"The current depreciation should probably come to a close in the near term," Tai Hui, chief Asia market strategist at JPMorgan Asset Management, said in a briefing in Hong Kong. "The authorities want to maintain domestic investor confidence. We are running up to the Group of 20 meeting in September and SDR inclusion in October and typically ahead of these key events, the currency is kept relatively stable -- again, to give people confidence."

--With assistance from Ran Li Emma Dong Karen Zhang and Jimmy Zhu To contact the reporter on this story: Justina Lee in Hong Kong at jlee1489@bloomberg.net. To contact the editors responsible for this story: Robin Ganguly at rganguly1@bloomberg.net, Sarah McDonald