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Above 7 per dollar: A new reality for Chinese yuan on trade war jitters

The Chinese yuan will weaken further beyond the current 7 per dollar rate over the coming year as Beijing steps back from managing the currency amid tariff threats from Washington, a Reuters poll of foreign exchange strategists showed.

twitter-logo Reuters        Last Updated: August 14, 2019  | 13:27 IST
Above 7 per dollar: A new reality for Chinese yuan on trade war jitters
Having protected it since the global financial crisis, Chinese authorities let the yuan breach the key psychological 7 per dollar rate last week.

The Chinese yuan will weaken further beyond the current 7 per dollar rate over the coming year as Beijing steps back from managing the currency amid tariff threats from Washington, a Reuters poll of foreign exchange strategists showed.

Having protected it since the global financial crisis, Chinese authorities let the yuan breach the key psychological 7 per dollar rate last week.

That came after U.S. President Donald Trump imposed an additional 10% tariff on the remaining $300 billion worth of Chinese imports and as Washington called China a currency manipulator for the first time in 25 years.

Since then, China's central bank has consistently set the yuan's daily mid-point reference rate above 7 to the dollar, only allowing it to move in a 2% range, weakening the currency to over an 11-year low of 7.0689 per dollar on Monday.

The poll, taken after those developments, predicted the yuan would weaken about 1% to 7.10 per dollar by end-October. It is then forecast to gain slightly to 7.06 in a year, close to where it was trading on Tuesday.

That is a complete U-turn in expectations from a survey taken last week when the yuan was forecast to have risen over 2% in a year, with the most optimistic call pencilled in for an 11% gain.

"We think it is unlikely that the USD/CNY will fall below 7 unless upcoming trade talks go particularly well, which is not our base case," said Iris Pang, Greater China economist at ING, who was second most accurate forecaster in Reuters polls for Asian currencies in 2018.

"The USD/CNY passing 7 shows that China is going to fight this trade war hard, at least while President Trump is in office."

The year ahead outlook for the renminbi in the latest survey was the most downbeat median in Reuters polls since June 2017. The most pessimistic forecast in the latest poll was 7.75 by Rabobank, a rate not seen since early 2007.

"In an environment which is going to be globally far more uncertain where China is growing much more slowly, you have more than a trade war - basically a Cold War between the two. It strikes me that you will end up having a massive depreciation in the renminbi," said Michael Every, Hong Kong-based senior Asia-Pacific strategist at Rabobank.

"Fundamentally, I do not see any way that you are going to get a clear trade deal that would last between the U.S. and China. We have got decades' and decades' worth of instability on that front ahead of us."

Rabobank's Every forecasts the yuan to depreciate around 20-25% to 8.5 or more against the greenback in the next two years.

A weaker yuan also raised risks of capital outflows, something China has been able to keep under control over the past year.

Additionally, a weak economic growth outlook and expectations of more policy easing by the People's Bank of China will exert further pressure on the yuan.

"China has probably determined that striking a deal with the U.S. is unlikely and it is time to allow the renminbi to fall to reflect fundamentals (weaker growth) and to dig in for a long-term stalemate," said Jason Daw, head of emerging markets strategy at Societe Generale, the most accurate forecaster for Asian currencies last year.

India's bond rally fizzles on government spending fears

A rally in government bonds, spurred by a large and surprise reduction in policy rates last week, has been cut short by renewed fears of government profligacy.

Since February, the Reserve Bank of India has cut the key policy rate by 110 basis points, which has pushed bond yields down significantly.

Ten-year yields hit 6.30% on Aug. 7, the day of the RBI's larger-than-expected 35 bps rate cut, and had fallen about 1.2 percentage points since February through the day of last week's cut.

Over the past four trading sessions, however, bonds have given up some of those gains with the 10-year yield up 31 bps on growing worries the government will boost heavy stimulus and borrowings to quickly accelerate growth.

"Expectations of a fiscal stimulus package seem to be gaining ground in the domestic market on the back of weak economic data and heightened slowdown concerns in the economy," economists at HDFC Bank wrote in a note. "We believe this could continue to pose as an upside risk to bond yields in the near future."

Despite much prodding by regulators, Indian banks have been reluctant to fully pass on the benefit of the policy rate cuts to their borrowers.

That is despite the government front-loading its spending for the year and the RBI injecting significant cash into the money markets.

In its budget proposals last month, the government set an ambitious fiscal deficit target for the year of 3.3% of gross domestic product, signalling its commitment to financial discipline despite economic growth languishing at near five-year lows.

But comments this month by Finance Minister Nirmala Sitharaman stating plans to improve the economy "fairly quickly" and speculation that there could be budget changes or new sector-specific stimulus have the bond markets worried.

Traders expect some small fiscal slippage and likely additional borrowing of around 400 billion rupees ($5.60 billion) above the targeted borrowing of 7.1 trillion rupees for the 2020 fiscal year.

Swings in global risk appetite and demand for risk-free sovereign bonds have also added pressure, traders said.

"Uncertainty over sovereign bonds is adding to the selling in bonds along with profit booking," said Paresh Nayar, head of fixed income and currency trading at First Rand Bank. "But the slowdown will call for more rate cuts."

Last week, a Reuters poll predicted the RBI would ease its benchmark rate by 25 basis points again to 5.15% at its October meeting, followed by a 15 basis point cut in the first quarter of 2020.

The rate cuts are expected to push down shorter-dated yields more than longer-dated yields, leading to a "bull steepening" of the yield curve.

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