Data You Need to Watch to Predict Where the Yuan's Going

(Bloomberg) -- The outlook for China’s currency eventually comes down to economic data -- and those aren’t looking quite as grim as the trade war headlines would suggest.

The yuan, Asia’s worst-performing currency after falling more than 6 percent since June, will likely be supported by an improvement in the economy through year-end and an inflow of money as foreign investors buy onshore bonds. In addition, capital controls and the still-growing foreign-exchange reserves should provide support.

The central bank is also expected to continue with monetary easing, which should help support the economy via cheaper money. In the short run though, with the U.S. raising rates, there’s a risk that the stimulus may weaken the currency and make yuan assets less attractive relative to those denominated in the dollar.

The onshore yuan rallied 0.20 percent to 6.8180 per dollar as of 5:46 p.m. on Thursday in Shanghai, while the offshore rate was little changed.

Here are six charts that offer some guidance on the outlook:

Investment and consumption will both rebound toward year-end, according to economists surveyed by Bloomberg. The nation’s senior leaders have signaled more support for economic growth, with greater emphasis on infrastructure construction. That’s in addition to tax cuts and the open market injections of cash by the central bank.

Foreign investors are continuing to pour cash into onshore bonds despite the yuan’s weakness in the past few months, increasing their holdings of mainland debt for a record 17 consecutive months through July, according to data from ChinaBond.

Overseas funds will keep snapping up assets, because Chinese bond yields are higher and the hedging costs for the yuan will remain low, according to Ken Peng, an investment strategist at Citi Private Bank in Hong Kong. That will help to offset capital outflows and cushion the currency as the trade war simmers, he added.

Onshore investors aren’t dumping yuan for foreign-exchange holdings, a popular trade a few years ago that sparked capital outflows and tighter regulations, according to data from China’s top currency market watchdog. And even if Chinese companies and individuals grow keen to sell, it would be harder due to government controls on flows. That eases another source of pressure on the yuan.

In the aftermath of 2015’s surprise devaluation to stabilize the yuan and stem outflows, policy makers burnt through billions in foreign reserves, but that isn’t happening now. China’s foreign-exchange reserves unexpectedly rose for a second straight month in July to $3.12 trillion.

The fact that the stockpile, still the world’s biggest, remains above $3 trillion could cushion confidence in the yuan. For Citi’s Peng, the central bank will avoid rapid drops in the reserves to "show the market that it has plenty of money if it hopes to intervene, and that will deter bears."

However, the nation’s competitive advantage in global trade has become less supportive for the currency. The current account fell to a $28 billion deficit in the first six months of this year, the first half-year shortfall since the data began in 1998. A shrinking goods trade surplus, rising services deficit, and foreign companies moving profits out of China all play a part in the shortfall.

Even though the current account will likely return to a moderate excess for the full year, the smaller surplus "could not only worsen the sentiment, but also reduce the buffer for policy makers when facing capital outflow," Larry Hu, head of China economics at Macquarie Securities Ltd. in Hong Kong, wrote in a recent note.

With policy makers turning their attention to support growth, investors are being offered the cheapest money in years. They are also betting that liquidity conditions will remain loose over the next 12 months, with the cost of one-year interest rate swaps hovering near the lowest level since late 2016.

Read: Chinese banks are stepping up sales of short-term debt amid low borrowing costs.

The central bank will continue to cut the ratio of deposits that banks are required to lock away throughout this year, according to a Bloomberg survey. The ratio will be reduced to 15 percent by the end of this quarter from 15.5 percent at present for major banks, and to 14.5 percent by the end of 2018, the survey shows.

To contact Bloomberg News staff for this story: Tian Chen in Hong Kong at tchen259@bloomberg.net;Xiaoqing Pi in Beijing at xpi1@bloomberg.net

To contact the editors responsible for this story: Jeffrey Black at jblack25@bloomberg.net, James Mayger, Will Davies

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With assistance from Editorial Board