Photographer: Tomohiro Ohsumi/Bloomberg

Yuan Slides Closer to Crisis Peg as Watchers See Bumpy Ride

  • Fed rate odds, seasonal dollar demand seen pushing yuan lower
  • Historical patterns show weakness may last 2-3 months: SocGen

The yuan may be in for a tough few months.

China watchers see a slew of reasons to expect weakness ahead, with the Federal Reserve poised to raise interest rates, Societe Generale SA flagging a historical pattern of two- to three-month drops and Deutsche Bank AG saying that the November-January period is especially stressful because of seasonal demand for dollars in China.

The yuan has declined 1 percent this month as expectations of a U.S. rate rise fueled a dollar rally and China’s central bank allowed its exchange rate to slip past 6.7, a level previously seen as its line in the sand. The currency is now just 1.3 percent off 6.83, the level at which China pegged the yuan after the 2008 global financial crisis. This is a turnaround from the August-September period, when policy makers were suspected of propping up the yuan before a Group of 20 summit and the yuan’s entry into the IMF’s reserves basket.

"The People’s Bank of China has kept the currency somewhat stable in recent months against the backdrop of a heavy political calendar," said Perry Kojodjojo, a strategist at Deutsche Bank in Hong Kong. "Given that the calendar lightens up now, and that we’re heading into a period when demand for dollars seasonally tends to pick up, I feel the PBOC should be comfortable to allow the currency to be more flexible and market-driven."

Deutsche says Chinese demand for the greenback will rise in the next three months because currency conversion and lending quotas are reset in the new year and banks accumulate more dollars to prepare for higher overseas credit card spending during Chinese New Year in late January. The U.S. currency has seen a surge of late, with the odds of a Fed rate increase this year shooting up to 64 percent from just 12 percent at the beginning of July.

"The U.S. dollar is appreciating broadly and a move up, which is supported by a modest tightening in monetary policy, is likely to be reflected in dollar-yuan trading," said Shaun Osborne, chief foreign-exchange strategist at Bank of Nova Scotia in Toronto. "The narrow trading range established by the PBOC in the wake of the financial crisis would likely serve as a target for the market and an indication of how much weakness the authorities may tolerate in the exchange rate into 2017."

While reports released Wednesday including on third-quarter economic growth and September retail sales met estimates, industrial production was below expectations. Data last week also showed exports unexpectedly shrank the most in seven months, which will motivate the PBOC to try to correct the yuan’s over-valuation, said Deutsche Bank’s Kojodjojo.

Tolerance Test

"It’ll try to control the pace but it’ll also try to inject more and more flexibility in the regime," said Harrison Hu, chief greater China economist at Royal Bank of Scotland Group Plc in Singapore. "They are trying to test the market’s tolerance, the market’s bottom line, to what extent the market can allow for continued depreciation against the dollar without becoming more panicky."

The PBOC, with verbal and suspected market intervention, has managed to guide the yuan lower without igniting the kind of turmoil it sparked in January with a set of weaker daily reference rates. The yuan has declined 3.6 percent this year, all but wiping out the gap between the currency’s current price and the median year-end forecast of 6.75 a dollar. The yuan in Shanghai was trading at 6.7384 late Thursday. The offshore yuan in Hong Kong fell toward a nine-month low, while a trade-weighted index slipped for the fifth day in a row, the longest run of declines since August.

"The consensus is too complacent to depreciation risks and the willingness of the PBOC to allow the renminbi to find its market-clearing level," said Jason Daw, Singapore-based head of emerging-market currency strategy at Societe Generale. China officially refers to the yuan as the renminbi, or the "people’s currency.”

— With assistance by Justina Lee, Tian Chen, and Lillian Chen

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