Yuan rides its own course

China’s reluctance to pursue yuan appreciation may be strategic.

IN late July, growing expectations for a US Federal Reserve rate cut and a Bank of Japan rate hike triggered a large-scale unwinding of global carry trade. While Asian currencies like the Indonesian rupiah and Malaysian ringgit outperformed the US dollar in August, strengthening by almost 5%, the yuan lagged behind, gaining only about 1.2%.

The yuan’s failure to capitalise on the unwinding of carry trade can be attributed to two key factors: the stable fixing rate maintained by Chinese officials and exporters’ low willingness to sell foreign currency.

Despite the yen’s sharp rebound initially, yuan fixing has been kept largely stable. The stability of the fixing rate suggests that the central bank is not in a hurry to leverage the situation to counter yuan short positions.

China’s reluctance to pursue yuan appreciation may be strategic.

First, it appears that China is using this opportunity to exit the indirect intervention that has persisted for over a year, as evidenced by the widening gap between estimated daily fixing and actual daily fixing.

Based on the pricing in the past two weeks, we believe the counter-cyclical factor in China’s daily fixing has been withdrawn.

The spot rate has been traded towards the daily fixing rate. This suggests that the daily fixing rate will now fluctuate entirely based on market supply and demand, as well as external market changes, implying higher currency elasticity.

Second, the stable fixing may also allow exporters time to offload their dollar holdings without incurring significant currency losses.

Chinese style carry trade

As China’s capital account is not yet fully open, unlike traditional carry trade by institutional investors, yuan carry trade is more often seen in the asset-liability mismatches of domestic enterprises and residents, such as exporters delaying foreign exchange settlements or residents increasing their foreign currency deposits.

For example, China’s onshore foreign currency deposits increased from the low of US$575bil in September 2023 to US$648bil as at July 2024.

As a result, the yuan’s outlook largely hinges on domestic players’ willingness to sell foreign currency, which remains cautious due to concerns over domestic fundamentals and potential US-China tensions.

The latest July data reflects this cautious sentiment, with the deficit from banks’ foreign-exchange purchases continuing to rise.

The willingness to sell foreign currencies rebounded to 61% in July from 58% in June, while the willingness to buy foreign currencies increased to 75% from 72%.

The simultaneous increase in both selling and buying willingness reflects the growing divergence in the market’s view on currencies, particularly following the unwind of carry trades in late July.

Overall, as the impact of unwinding carry trade fades, the yuan’s trajectory will likely depend more on exporters’ willingness to sell foreign currency. This could lead to a weakening correlation between the yuan and other Asian currencies, such as the ringgit, in the near term.