The selloff in the yuan intensified on Tuesday, spilling into other assets, but isn’t yet reason for panic, analysts said.
The yuan, both in its onshore USDCNY, -0.1187% and offshore USDCNH, +0.0618% form, first hit a 5-month low on Monday when currencies reacted to the heightened trade tensions between China and the U.S.
Late Monday, President Donald Trump threatened further tariffs and on Tuesday the currency dropped through its 200-day moving average.
The People’s Bank of China has been watching this market-driven devaluation from the sidelines so far, analysts said, and it should remain hands-off for now.
“It’s hard to see why Beijing would want to actively weaken its currency, via intervention, given it would mean its exposure to the U.S. via holdings of U.S. Treasurys would likely increase as a result, unless it diversified the fresh FX reserves at a particularly aggressive pace,” wrote Simon Derrick, chief currency strategist at BNY Mellon, in emailed comments.
Actively weakening the yuan would increase China’s foreign-exchange reserves — much of which are in U.S. dollars — something the central bank has said it doesn’t want.
“How China manages the yuan is a strategic decision and it is unlikely to accelerate the depreciation to compensate for the 25% tariff,” said Marc Chandler, global head of currency strategy at Brown Brothers Harriman. “A devaluation of sufficient magnitude to blunt the tariff would likely open the proverbial Pandora’s box and spur the vicious cycle of outflows and depreciation and set back China’s other strategic goals.”
As Chinese market participants returned from Monday’s holiday, they were already met with increased turbulence on Tuesday. Chinese equities also got clobbered on Tuesday, with the Shanghai Composite Index SHCOMP, -0.59% dropping 3.8% and closing below the psychologically important 3,000 level.
Should the trade spat remain at the forefront of market drivers for a prolonged time, volatility across assets could increase and the current wobbles could turn into a much bigger beast, market participants said.
But just as before, the yuan still sold off less than the rest of the region that is also tied to the U.S.-China trade complex. Taiwan and South Korea, for instance, are in many cases part of the supply chain of goods imported to the U.S. via China.
Also notable, while the yuan reached a fresh five-month low against the greenback, “against the basket [of broader rivals], we are seeing limited stress in the yuan. It is in fact down just 0.35% from the peak on May 21 and up about 2% over the past five months,” said Sue Trinh, head of Asia FX strategy at RBC Capital Markets, referencing the CFETS Yuan Index.
A yuan selloff across the board, rather than just against the U.S. currency, would be a whole different story.
That said, “with the yuan at around a two-year high against the basket, there is room for China to move if it wants to use the yuan in a trade war,” Trinh said.
The relative stability in the onshore currency forward market “tells a similar story of limited stress compared to the disorderly devaluation episode seen across 2015 [and] 2016,” she said. This could reflect market complacency about the effect of a trade war on the yuan or a market that “still doesn’t believe recent developments will escalate and is hoping cooler heads will prevail.”