Chinese yuan rallies against the dollar but weakens against other currencies: what’s driving the divergence?
The Chinese yuan’s recent rally against the greenback may still have room to run as Beijing guides the currency higher and is seen as favoring holding off on the next rate cut. However, the yuan’s drop against other major currencies is stoking renewed trade friction. The offshore yuan has gained about 3% against the dollar this year, as the U.S. dollar tumbled against all major currencies for a mix of reasons, including America’s economic slowdown, its rising debt burden and foreign policy uncertainty. The U.S. dollar index has declined over 10% so far this year, on track for its worst year in more than two decades, according to LSEG data. The offshore yuan last traded at 7.118 per dollar as of Monday, hovering near its strongest level since U.S. President Donald Trump’s presidential election win on Nov. 5. Economists expect the yuan could strengthen to 7 per dollar by the end of this year — a conviction driven in large part by Beijing’s efforts to revive economic growth and encourage more investment onshore. Meanwhile, the yuan has weakened markedly against other currencies, including the euro, British pound and Japanese yen, making Chinese exports more competitive in these markets as its trade tensions with Washington curb shipments to the U.S. The yuan has weakened over 10% this year against the euro, 5% against the pound and 3% against the yen, according to LSEG data. “The divergence [of] yuan’s appreciation against the dollar and depreciation against others is largely due to a weak dollar that’s unseen for many years,” said Tianchen Xu, senior economist at Economist Intelligence, who expects the gap to persist. The yuan’s depreciation against other currencies will be “conducive to [Chinese] exporters because they are now increasingly exporting to non-U.S. countries,” Xu added. China’s export mix is shifting. Less than 10% of its shipments went to the U.S. in August, down from 15% last year, while shipments to Southeast Asia, the European Union, Africa and Latin America grew. Policy dilemma The yuan’s expected appreciation against the dollar reflects rising bets on a Federal Reserve rate cut later this week and falling U.S. yields that have narrowed the U.S.-China spread, boosting the appeal of Chinese assets, along with Beijing’s efforts to bolster the economy. Traders see a 94.2% chance the Federal Reserve will cut its key interest rate by a quarter point this week, according to CME Group’s FedWatch tool, which measures odds of Fed action based on the 30-day Fed funds futures contracts. A blistering stock market rally has also put the central bank in a policy dilemma with worries that a near-term interest rate cut could risk repeating the mistakes in 2014-2015 when aggressive monetary easing and retail speculation ended in a market collapse. That leaves the People’s Bank of China in a bind — while rolling out rate cuts could “fan the flames and inflate a stock market bubble, doing nothing risks worsening the growth slowdown,” said Ting Lu, Nomura’s chief China economist. Concerns are mounting that the recent surge in Chinese onshore stocks has been fueled by excess liquidity. From its lows in September 2024, the benchmark CSI 300 Index has surged by over 43% as of Monday, thanks to a recent rally driven by state-backed buying and a wave of retail investors rotating out of low-yielding deposits into stocks, LSEG data show. “Beijing needs to tread carefully over the next couple of months, and the PBOC might be reluctant to follow the Fed in cutting rates in September,” Lu said, adding that it may deliver a modest 10-basis-point rate cut over the coming weeks if the markets correct. The central bank has also been setting its daily reference rate stronger — around which the onshore yuan is allowed to trade within a 2% range — near its strongest level seen in last November, allowing a gradual appreciation against the dollar. It last set the reference rate at 7.1056 on Monday. “RMB is transitioning from prolonged stability to a carefully steered grind higher,” said Tommy Xie, head of Asia macro research at OCBC Bank, who expects the offshore yuan to strengthen to 7.08 per dollar by year-end. That was contrary to the consensus opinion at the start of this year that Beijing would weaken the yuan against the dollar to offset U.S. tariffs, keeping Chinese goods competitive in the world’s largest consumer market. “The unusual appreciation bias in the PBOC’s daily fixing [could be seen as] a ‘goodwill gesture’ from the Chinese government amid ongoing trade talks with Washington,” Goldman Sachs economists said in a note dated Sept. 1, as the Trump administration has made a weaker dollar one of its economic priorities. The Wall Street bank expects the onshore yuan to reach 7.0 by year-end. Trade friction Beijing may be concerned about the growing trade frictions with other trading partners, given the yuan’s significant depreciation against other major currencies so far this year, said Larry Hu, chief economist at Macquarie. He pointed out that the yuan’s real effective exchange rate, which is a gauge of the yuan’s competitiveness adjusted for inflation, has fallen to its lowest level since December 2011. That depreciation has made Chinese exports more competitive in the importing markets, contributing to a widening trade imbalance, drawing the ire of major trading partners, including BRICS member state India. Earlier this month, India urged the bloc members to address their trade imbalances with New Delhi. China recorded a trade surplus of $77.7 billion with India in the first eight months this year, according to CNBC’s compilation of the official customs data, 16% higher than the same period last year. Mexico’s government has also proposed to raise tariffs on vehicles coming from Asia, particularly China, to 50% from the current 20% as part of a broad overhaul of import levies that the government planned to protect its local industries. “Beijing has been engaged in what I called opportunistic devaluation,” where it effectively used the dollar’s decline to “engineer a devaluation” against the euro and other currencies, Stephen Jen, who runs Eurizon SLJ Capital, said in a recent interview. “A more reasonably priced renminbi and a less predatory exchange rate policy would earn China some goodwill from the rest of the world,” the asset manager said.
