Who’s Crazy Now? Yuan Bears Vindicated by Tumble See More Pain

Updated on
China’s Yuan Support Ends 2-Day Rout

Sue Trinh had to defend her sanity. Albert Edwards almost got kicked out of meetings. Kevin Lai was ignored by clients for an entire year.

Once ridiculed for their bearish forecasts on China’s currency, the analysts who predicted this week’s devaluation don’t look so crazy now. As investors around the world ask what happens next, the forecasters who got it right say the yuan has further to fall.

“Some investors told me I was crazy,” Trinh, the senior currency strategist at Royal Bank of Canada in Hong Kong who predicted a yuan retreat in June, when most of her peers were forecasting a stable or stronger exchange rate. “The renminbi was misaligned with fundamentals.”

While a weaker yuan looked inevitable to Trinh, the central bank’s decision to devalue the currency on Tuesday took markets by surprise -- sparking a selloff in global equities and emerging-market currencies. Further weakness could exacerbate capital outflows, make $3 trillion of dollar-denominated debt more expensive for Chinese borrowers and put pressure on export rivals to devalue their own currencies.

“I see this going a lot further,” said Edwards, a global strategist at Societe Generale SA in London who’s been calling for a yuan devaluation for at least 18 months.

Yuan Forecasts

Trinh predicts the yuan will depreciate another 2.5 percent by year-end to 6.56 per dollar, while Lai at Daiwa Securities Co. has a target of 6.6, a level last seen in early 2011. The median estimate of 40 analysts surveyed by Bloomberg before the devaluation was 6.20, in line with the rate maintained by the People’s Bank of China for about four months before this week.

The PBOC’s daily fixing for the yuan fell by 1.1 percent on Thursday, after declines of at least 1.6 percent the previous two days. Under the new methodology, market makers who submit contributing prices for the reference rate have to consider the previous day’s close, foreign-exchange demand and supply, as well as changes in major currency rates.

RBC's Trinh Sees Yuan Falling to 6.95 by Late 2016

The yuan closed 0.2 percent weaker at 6.399 in the spot market at in Shanghai, extending its drop this week to about 3 percent. The PBOC will keep the yuan stable at a reasonable, equilibrium level, it said in a statement delivered ahead of a rare press briefing Thursday.

Chinese authorities had been propping up the yuan, contributing to an almost $300 billion drop in foreign-exchange reserves over the last four quarters, as policy makers sought to deter capital outflows and encourage global usage of the currency.

‘Too Painful’

“For almost a year people didn’t pay attention,” said Lai, Daiwa’s Hong Kong-based chief economist for Asia, excluding Japan. “The market in general still doesn’t understand how the exchange-rate policy in China works. It’s not about exports, it’s about money supply. If you have a lot of money coming in for 10 years, it has to leave at some point. And you can use your foreign reserves to protect your currency, but using that is too painful” as it drains yuan from the economy.

Lai said his forecast of a decline to 6.60 a dollar, which was made more than a year ago, may be reached “in the next few days,” and that there’s scope to revise it lower.

Chinese companies that borrowed in foreign currency at a record pace in the past three years will buy dollars to protect against losses, he said. In reports as early as March 2014, Daiwa outlined how fake export invoicing, metals purchases and disguised foreign investment had driven $1 trillion of hot money inflows.

Fair Value

“As the selling pressure increases, this could spin into a currency and a credit crisis,” he said.

China’s one-year sovereign bond yield has climbed 14 basis points since the devaluation, while the cost to insure the nation’s debt against default jumped to a two-year high.

The yuan’s tumble roiled Asian currencies and equities this week. Malaysia’s ringgit sank to the weakest level since 1998, while the Singaporean and Taiwanese dollars slumped to five-year lows before rebounding on Thursday. The MSCI Emerging Markets Index of shares entered a bear market.

If the yuan’s level versus trading partners is any guide, its slump is far from over. China’s real effective exchange rate, a measure adjusted for inflation and trade with other nations, climbed 13 percent over the last four quarters and was the highest among 32 major currencies tracked by Bank for International Settlements indexes. RBC estimates the yuan was 15 percent overvalued before Tuesday’s devaluation.

“We are far from fairly valued,” Trinh said. She predicts the yuan will drop to 6.95 a dollar by the end of 2016, a level last seen in May 2008.

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