Yuan Bulls Near Extinction Keep Faith in Power of People's Bank

  • Four out of 41 analysts predict the Chinese currency will gain
  • Monetary easing to spur manufacturing, Prestige Economics says

Yuan bulls, a species so rare as to be almost extinct, are keeping faith in the People’s Bank of China.

Just four out of 41 analysts predict the Chinese currency will advance against the dollar by June 30, compared with 25 of 40 before the PBOC’s Aug. 11 devaluation, data compiled by Bloomberg show. Swissquote Bank SA, the most bullish, expects the world’s second-largest economy will improve next year, while Prestige Economics LLC says investors are too pessimistic and that easing monetary policy will drive growth.

“I don’t look to be a contrarian,” said Jason Schenker, president of Prestige Economics in Austin, Texas, who forecasts a 1.3 percent gain. "Right now, things could be quite bearish for China. But nine months or a year from now, we could be in a situation where the accommodating monetary policy has had enough time to generate more growth and modest optimism.”

The yuan has dropped 2.5 percent this year and touched a four-year low a day after the devaluation, amid the central bank’s move to a more market-based fixing regime. Governor Zhou Xiaochuan has since lowered borrowing costs twice -- bringing the number of cuts to six in 12 months -- as the economy heads for the slowest expansion in 25 years. He also intervened in the foreign-exchange market to engineer a 0.4 percent rally in the currency and rein in capital outflows.

“The central bank or government now prefer to keep the yuan rate stable and to avoid any expectations of a devaluation trend," said Manuel Andersch, a Munich-based economist at Bayerische Landesbank, which forecasts a 0.95 percent appreciation by end-June. "They continue to be willing to spend a huge amount of reserves to ensure that. Having said that, we expect higher volatility around our forecast path than in the past."

The Chinese currency dropped 0.15 percent to 6.3624 per dollar as of 10:48 a.m. on Monday in Shanghai, after falling 0.6 percent last week, as data showed exports and imports that contracted more than economists forecast. Bets the Federal Reserve will raise interest rates this year also boosted the greenback.

Commonwealth Bank of Australia and Rabobank are among those predicting China will allow a rapid weakening of the yuan by July 2016 to boost exports. CBA last month predicted a drop of more than 3 percent within a few days as soon as this year. While a private gauge of manufacturing for October beat estimates, it showed the sector was still contracting. Gross domestic product grew 6.9 percent in the third quarter from a year earlier, the slowest pace in more than six years.

Political Pressure

Given tensions at the Group of 20 meeting over global currency wars in September, Chinese policy makers are likely to be acutely aware of how depreciation will play out during a U.S. election year. They also have to strike a balance between removing capital restrictions and ensuring exchange-rate stability to bolster the currency’s case to be included in the International Monetary Fund’s reserves.

A gauge of yuan swings for one month surged to 9.76 percent on Aug. 13, before falling back to 4.2 percent this week. Another sign of stability is that foreign-exchange reserves rose $11 billion to $3.53 trillion in October, after dropping $43 billion and $94 billion in the previous two months amid dollar-selling intervention.

“The perception of currency manipulation due to the recent devaluation has hurt the yuan’s investibility in the eyes of global participants," said Peter Rosenstreich, head of market strategy at Swissquote Bank in Gland, Switzerland. "Steering appreciation back to pre-intervention levels can help relieve some of the negative stigma."

He forecasts that the yuan will gain 1.8 percent by June 30 and recommends buying Chinese sovereign bonds in the offshore market as they offer a “significant premium for yield-starved investors.” The yield on Dim Sum government bonds due May 2020 was at 3.3 percent on Monday, 155 basis points above that on similar U.S. debt, according to data compiled by Bloomberg.

"We expect the interest-rate and reserve-ratio cuts will eventually have a positive uplift for manufacturing," said Schenker at Prestige Economics. "We also expect more reductions between now and then. These policy cuts result in more growth. You get a short-term currency weakness but then you’ll get an appreciating currency."

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