Chinese one-hundred yuan banknotes (Photographer: SeongJoon Cho/Bloomberg)

Trump May Be Shooting Blanks on Yuan Devaluation `Warning Shot'

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(Bloomberg) -- Donald Trump’s "warning shot" to China and Russia this week on gaming their currencies is more of a damp squib -- at least as far as the world’s second-largest economy is concerned.

The yuan has been heading up against the dollar, not down, and looks set to at least stabilize this year. The onshore yuan (CNY) rose 3.7 percent through April 16, while the offshore yuan (CNH) climbed almost 4 percent, marking its best-ever gains in the first quarter. Extrapolate those increases for the year and pretty soon you’re looking at a whopping 14 percent annual rally.

Analysts who in the first quarter were calling for the yuan to depreciate have gradually shifted course. Many now expect the currency to remain strong, though they don’t see it appreciating at anything close to its torrid pace so far. Goldman Sachs revised its forecast in late March, saying the Chinese currency to reach 6.30, 6.25 and 6.20 to the dollar in three, six and 12 months, compared with its prior estimate of 6.35, 6.40 and 6.45.

UBS Wealth Management said in an April 11 note that the yuan will remain stable during the next six months. The firm favors long yuan positions, saying China won’t allow the currency to weaken despite a sliding dollar. And Nomura Holdings bolstered its long yuan positions after President Xi Jinping pledged greater market openness at last week’s Boao Forum, according to a note from the company’s Asia-based analysts.

Further appreciation could send yuan toward the key 6.20 level, around which both the CNY and CNH consolidated for almost half a year in 2015 before a sudden devaluation of more than 2 percent on Aug. 11. For the more freely traded and less regulated CNH, a breach of 6.20 could open a path toward 6.1113, a high last reached in the fourth quarter of 2014, and then onto 6.0161, the all-time high set in early 2014.

Forward contracts show the offshore yuan will trade at about 6.31 to the dollar in six months. That compares with about 6.60 at the end of last year and 6.40 in January. The yuan would need to rally more than 4 percent to test its all-important 6.00 level, though that move wouldn’t be a fast, one-way bet. China will probably resist a massive, single-directional appreciation, according to a Bloomberg interview with central bank adviser Sheng Songcheng.

Why Resist?

China doesn’t have much reason to resist a modestly stronger yuan, said David Loevinger, a managing director and sovereign analyst at TCW Group. Appreciation is easier politically than taking on domestic interests to scale back restrictions on U.S. goods and services, he said in an interview. Tightening monetary policy via exchange-rate channels, at a time when China’s export performance is strong, is more appropriate than raising interest rates when leverage in the financial system is still relatively high.

After successfully reining in capital outflows and tamping down devaluation expectations, policy makers may soon face a different type of challenge: Bringing the pace of yuan appreciation under control.

  • NOTE: George Lei is an FX strategist who writes for Bloomberg. The observations he makes are his own and not intended as investment advice
  • Some information comes from FX traders familiar with the transactions who asked not to be identified because they are not authorized to speak publicly

©2018 Bloomberg L.P.

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