Yuan depreciates and passes a key threshold; a new warning for the Chinese economy

On Wednesday, the yuan depreciated to pass a key threshold of 7 units to the US dollar, the first time this year and a fresh sign that the world’s second-biggest economy is failing to recover after reopening.

The currency depreciated in both onshore and offshore markets after data this week showed that factory output, retail sales, and fixed asset investment grew less than expected in April.

The country’s benchmarks lag behind their mainland peers, while sovereign bonds have risen on expectations of further monetary easing.

“We had thought that stronger sentiment thanks to China’s sharp reopening and subsequent improvement in some economic data would strengthen the yuan, but this hasn’t materialized,” said Kiyong Seong, a chief macroeconomic strategist for Asia at Societe Generale Hong Kong Branch.

“The threshold for market players to position in favor of a stronger yuan turned out to be much higher than we expected.”

Some six months after China abruptly ended its restrictions on yuan trading, optimism about the rebound in the domestic economy that had boosted yuan assets is now bumping up against reality.

The currency has fallen more than 4% from its January peak as traders lose patience due to lackluster economic data.

On Wednesday, the yuan fell 0.3% to 7.0201 per dollar, extending this year’s decline to 1.3%. The domestic currency fell 0.4% to 7.0026.

China’s huge trade surplus is not translating into a strengthening yuan, and the country’s relatively unattractive yields compared to the US are a major deterrent.

Exporters also seem reluctant to sell dollars, fearing that the yuan will fall further.

Some have been selling short-term yuan put options to secure a better price, according to traders who asked not to be quoted because they are not authorized to speak publicly.

At least so far, the People’s Bank of China has stayed on the sidelines in the currency market and its liquidity operations.

On Wednesday, it refrained from helping sentiment by issuing a stronger benchmark rate for the yuan, and it also avoided cutting its policy lending rate earlier this week.

“With no sign that China’s central bank is trying to curb yuan weakness at the moment, this has emboldened the bears,” said Khoon Goh, head of Asia research at Australia & New Zealand Banking Group Ltd. in Singapore.

But “don’t forget that the PBOC has a lot of tools it can employ, and market participants will likely be wary of taking yuan weakness too far,” he said.

The PBOC set the currency fixing, which limits onshore yuan movements by 2% on either side, at 6.9748, in line with forecasts in a Bloomberg survey of analysts and traders.

The Bloomberg Dollar Index rose 0.2% on Tuesday as improving US data pushed Treasury yields higher.

PSYCHOLOGICAL BARRIER

People’s Bank of China Governor Yi Gang said in March that the 7 per dollar level was no longer a psychological barrier to the yuan, as the exchange rate mechanism has been increasingly flexible and increased volatility has not posed a problem for companies or households. China has largely ended currency intervention, he said in April.

The PBOC has many ways to curb yuan weakness when it is uncomfortable.

The central bank often uses fixing to guide expectations, used to jawbone the currency, and can become more aggressive by raising the cost for traders who short the yuan.

According to Nomura Holdings Inc (NMR), there are still a few signs of discontent over the yuan’s weakness.

“The PBOC’s level of concern may not be 7.0, but rather towards 7.30″, and the probability of intervention is low in the near term, strategists at the bank led by Craig Chan in Singapore wrote in a research note.

With information from Bloomberg

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