An employee at a currency exchange store counts Chinese one-hundred yuan banknotes in Hong Kong, China (Photographer: Xaume Olleros/Bloomberg)

Yuan Calm at Risk of Ending as China Share Drop Darkens Mood

(Bloomberg) -- A selloff in Chinese stocks is threatening to end the yuan’s calmest period since its devaluation 20 months ago.

Further equity declines could have a contagion effect on the currency, pushing it out of the narrow range that it has stayed in for almost three months, according to Banco Bilbao Vizcaya Argentaria SA and Australia & New Zealand Banking Group Ltd. This is in addition to a slew of other risks, including potential easing of capital controls, as well as U.S. interest-rate increases and geopolitical tensions that could spur renewed strength in the dollar.

“When investors figure they don’t want to play with the A-shares, they will use the money to buy the dollar or find a way to purchase overseas assets," said Xia Le, Hong Kong-based economist at BBVA, the yuan’s most-accurate forecaster as ranked by Bloomberg. "The stability in the yuan will be short-lived. The central bank, an opportunist in managing the exchange rate, will also depreciate the yuan when it sees the right chance, and the next one will likely come in May, when the dollar rises on bets for further U.S. hikes.”

The yuan, which has traded in a 1.1 percent range since February due to tightened capital controls and a weakening greenback, hasn’t budged more than 0.2 percent in the past week. This is in sharp contrast to the stock market, with the Shanghai benchmark tumbling 3.2 percent in the four sessions through Wednesday amid talk of increased scrutiny. Liu Shiyu, the country’s top securities regulator, said over the weekend that the nation’s bourses should punish market irregularities “without mercy.”

Chinese policy makers have kept the yuan stable so far this year because they want to steady sentiment, and they will resume depreciation once the market is relatively confident, said BBVA’s Xia. The yuan will weaken and break out of its recent trading range if the equity declines continue, said Khoon Goh, Singapore-based head of Asia research at ANZ. Goh expects the yuan to end this year at 7.1 per dollar, from 6.8835 on Thursday.

Yuan Calm at Risk of Ending as China Share Drop Darkens Mood

The yuan has advanced 0.9 percent so far this year -- swinging from a 6.5 percent tumble in 2016 -- as outflows eased amid capital controls, the economy clocked its first back-to-back acceleration in seven years and the Bloomberg Dollar Spot Index posted its biggest quarterly loss in a year. Policy makers are also getting a hand from U.S. President Donald Trump, who refrained from branding China a currency manipulator in a foreign-exchange report this month.

The A-share market, on the other hand, has tumbled. Liu Shiyu, who took over the helm of the China Securities Regulatory Commission last February after the equity market fell apart, has been quick to put down any signs of speculative activity. Last year he labeled as “robbers” insurers conducting leveraged buybacks. The insurance regulator took a series to steps to curb short-term speculation, while China’s anti-graft agency announced this month that it is probing the top insurance official for disciplinary violations.

On Friday, the CSRC said it will continue to crack down on market violations, adding that it has fined an ex-Shenzhen stock exchange official 251 million yuan ($36.5 million), confiscated 248 million yuan and and banned him for life.

Added Risks

Among the other dangers to the yuan are a potential easing of cross-border capital restrictions.

“China may start to ease capital controls in the second half of this year, and then outflow pressures could resurface, keeping the yuan rally in check," said Ken Cheung, a Hong Kong-based currency strategist at Mizuho Bank Ltd. "Also, the Federal Reserve may turn hawkish and shrink its balance sheet, which will support the dollar."

Cheung forecasts the yuan to weaken 3.1 percent to 7.1 per dollar by the year-end, in line with the median estimate of 7.08 in a Bloomberg survey.

“The resumption in the yuan’s drop will be triggered by a recovery in the dollar, which will happen later this year,” said ANZ’s Goh. “Other risks include the North Korea tension, the French election this weekend and German polls later in the year.”