Thought August 05, 2019 / 02:10 am UTC

China: PBoC Signaling That It Allows a Weaker Yuan

By Jeff Ng

The People’s Bank of China (PBoC) has allowed its fixing to move in line with market forces. This was significant after it supported its currency for the most part of 2019. The CNY has weakened in response and we see an increasing chance of USDCNY hitting 7.20 by end-2019.

The PBoC had previously fixed its daily USDCNY below 6.9000 even in times of upside pressures. Its fixing of 6.9225 on August 5 was the highest on record after USDCNY closed the previous session at 6.9420.

The move signals that the PBoC is allowing its currency to move with market forces. It also opened the floodgates towards a weaker yuan (higher USDCNY), as it moved to above-7 levels in response, to 2008 levels.

The CNY is poised to weaken further. Weakening economic fundamentals, escalating U.S.-China trade tensions and risk aversion are still likely to outweigh the rebound in China’s current account surplus and the Fed stance converging closer to PBoC accommodation. 

We previously wrote about what will move the yuan, as expectations were stabilized by PBoC support. Since publication, all three scenarios have happened in some form. 

1) The Fed has cut policy rates but strengthened risk aversion in the process. 

2) The U.S./China trade situation has moved toward an irreconcilable and irrevocable situation, as U.S. President Donald Trump appears to take advantage of Fed cuts to protect the U.S. economy from the trade war. 

3) China’s daily fixing on August 5 has also signaled that it is shifting its policy stance. This may trigger the U.S. labeling China a "currency manipulator" as the trade spat spills to other areas. While we expect no changes to its current monetary policy stance, a further shift may move USDCNY further.

Given these factors, the chances of CNY weakening further have risen. The probability of USDCNY rising to 7.20 by end-2019 has risen to 35%, from 10% before. Other regional currencies also look set to weaken with the CNY. 

Figure 1: USDCNY since 2005

Source: Bloomberg, Continuum Economics

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