Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Chinese yuan bears are undeterred by PBoC’s grip
Charu Chanana
Chief Investment Strategist
Summary: The downside pressure in Chinese yuan is ramping up even as the People’s Bank of China (PBoC) tries to maintain its grip. Given macro fundamentals and USD resilience, it appears that the path of least resistance for USDCNH could be neutral to higher. Meanwhile, weaker Chinese yuan is a play on Trump risks while providing a positive carry.
Both the onshore and offshore have weakened in Q1. USDCNH is back above 7.25 for the first time since November 2022 and has traded more than 2% weaker than the PBoC’s fixing for onshore spot every day since March 22. USDCNY is also testing the upper bound of the PBoC’s trading band as shown in the chart below.
The breakout began after traders were spooked by the PBoC fixing the CNY mid-rate above 7.10 for the first time in two weeks on March 22. This fuelled speculation that China’s central bank is loosening its grip on the yuan and could let it weaken. Despite the PBoC reversing its fixing to below 7.10 levels the following day, yuan bears were undeterred and this serves as a bearish signal. CNH-CNY spread is over 200 pips, also signalling bearishness.
Dollar resilience has also contributed to weakness in the Chinese yuan, but there are several other reasons why markets could continue to test the PBoC’s grip, as listed below.
- Macro lens supports a weaker yuan: Amid weaker Chinese consumption, there's a growing emphasis on exports to support the economy, making a weaker yuan more logical than a stronger one.
- Weaker Japanese yen is worrisome for China: Continued depreciation of the Japanese yen poses a challenge for Chinese authorities due to heightened competition in export markets, potentially eroding China's export competitiveness.
- Geopolitical risk play: Weaker Chinese yuan serves as a thematic bet on geopolitical uncertainties, particularly if Trump maintains a lead in polls ahead of the November elections which will bring tariff concerns.
- Long USDCNH is a positive carry: While it may be fair to expect that the Chinese authorities are unlikely to let the yuan weaken in a disorderly manner given the risks facing the Chinese economy at this time, there is still a case to be made for incremental weakness as noted above. Even if USDCNH remains range-bound, the pair has a positive carry because US yields are significantly higher than Chinese yields. This means that you get paid to hold on to it as you position for the US election risk.
- Positioning and technicals are supportive: Positioning in yuan is neutral, and the triple top resistance around 7.2330 is now serving as a support.
Still, risk management is prudent as yuan remains firmly in control of the PBoC. A weaker USD can also push the yuan to stronger levels, as can a steep recovery in the Chinese economy.
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