Chart Of The Week   April 22 2022

Yuan Slides Amid Fed-PBoC Policy Divergence

bearish yuan

The RMB slid 2% last week in an aggressive selloff that abruptly pushed the currency to its weakest level since August.

Multiple forces are behind this weakness.

First, PBoC policy has diverged from its global peers. The Chinese central bank is easing monetary policy to stimulate the domestic economy while other central banks are raising rates aggressively in response to surging inflation. The US-China interest rate differential has collapsed. This development has eliminated the appeal of China’s bond market for foreign investors.

Furthermore, China’s trade surplus is starting to narrow. A surge in foreign spending on goods during the pandemic benefitted Chinese exporters and caused the country’s trade surplus to balloon over the past two years. However, foreign consumer spending patterns are now shifting in favor of services over goods as economic activity normalizes – a headwind for Chinese exports.

In addition, deteriorating economic conditions have soured foreign investors’ sentiment towards Chinese financial markets. Weak demand among businesses and households and the sluggish property market are limiting the effectiveness of stimulus measures. More recently, lockdowns are constraining economic activity and disrupting supply chains. The CSI 300 is the worst performing major equity market so far this year, down 21% in USD terms. There are no signs that authorities are willing to abandon the zero-COVID-19 approach with President Xi Jinping reiterating his commitment to the policy as recently as last week.

The PBoC set a lower than expected midpoint for the RMB’s dollar trading band last Wednesday. The central bank may be getting uncomfortable with how much the currency has strengthened over the past few years. A weaker currency ultimately boosts the competitiveness of Chinese exports.

Given that these dynamics are likely to continue over the coming months, the near-term outlook for the RMB remains negative.