China’s Yuan Ends May in Pain With Weaker Dollar Failing to Help

A bad April for the yuan has turned into a worse May, with its failure to rebound amid broad dollar weakness a warning sign that bearish sentiment risks snowballing.

The yuan has fallen against almost all major currencies this month and is once again approaching the limit of its fixed trading band against the greenback. Fueling the decline are bets investors will keep dumping Chinese assets in favor of higher returns elsewhere and concerns the local economy will remain fragile.

The weakness is alarming even for a currency used to being under attack, as it’s potentially the first month this year that the yuan has fallen despite a broad drop in the dollar. That suggests pressure is now coming mainly from pessimism toward China’s fundamentals, so further dollar declines won’t necessarily bring a significant boost.

While the fall risks triggering an official pushback, this will also amplify voices calling for Beijing to embrace the weakness as it helps support the economy by benefiting sluggish exports. In fact, policymakers may already be doing that with the People’s Bank of China slowly guiding the currency weaker with its daily reference rate.

“Continued dollar strength, persistent domestic weakness, deflation risks are likely to push dollar-yuan higher,” said Chidu Narayanan, head of the macro strategy Asia-Pacific at Wells Fargo & Co. “We expect dollar-yuan fixes to creep up slowly in this environment.”

The yuan had a strong start to the month on bets the US might be inching closer to its rate-cut cycle. However, the optimism was soon outweighed by concerns over China’s underwhelming stimulus, signs of extended fund outflows and trade conflicts between the world’s two largest economies.

So far in May, the yuan has declined versus all 31 major currencies except for the Argentine peso, according to data compiled by Bloomberg. It’s also headed for the worst month in almost a year versus a basket of 24 trading partners’ exchange rates.

“The yuan will continue to underperform most other Asia ex-Japan foreign-exchange because of fragile growth outlook and trade frictions with Western peers,” said Fiona Lim, senior currency strategist at Malayan Banking Berhad. 

That said, the PBOC doesn’t seem to be in a rush to fight bears because there are few signs of a panic selloff or spillover to equities and bonds. Beijing might even be taking advantage of recent dollar weakness to greenlight some yuan declines with slight cuts to its daily fixings.

Such bets led to an acceleration in the selloff this week, with the yuan sliding to touch the lowest since November and being a whisker away from the weak end of its trading band.

‘Vicious Cycle’

Looking ahead, Standard Chartered Bank echoed Maybank saying the yuan will continue to trail peers especially in times of dollar weakness. That’s because it benefits less from drops in the greenback given it’s a managed currency, according to Becky Liu, head of China macro strategy at StanChart.

In the longer-term, the yuan’s fate is dependent on China’s economy. In recent weeks, policymakers have rolled out a raft of measures to aid growth, such as cutting down-payments for home purchases and kick-starting the issuance of special government bonds.

“Yuan weakness and capital outflow seems to be a vicious cycle and this can only be reversed by a more benign dollar and rates environment or a revival in economic confidence at home,” said Maybank’s Lim. “Both of which seem a tad elusive for now.”

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