(Bloomberg) -- China’s yuan slid the most in a week following a report that Beijing is considering allowing the currency to weaken next year in response to the threat of a trade war with the US.
The offshore yuan dropped as much as 0.5% to 7.2921 per dollar after Reuters reported that policymakers are mulling letting the currency depreciate, possibly to around 7.5 per dollar. It later trimmed declines.
The move triggered drops in regional peers, with the New Zealand dollar falling to the weakest in more than two years, while the Australian dollar hit levels last seen in November last year.
Pressure on the yuan has intensified since the re-election of Donald Trump, who has threatened to impose tariffs on China and other countries. Some investors have speculated Beijing will abandon its current policy of maintaining a stable currency to compensate for any impact this could have on its economy.
“There is a compelling logic embedded in these comments,” said Jane Foley, head of FX strategy at Rabobank in London. “China’s economy is already weak, inflation is low, and it will have to position itself for Trump tariffs.”
But devaluing the yuan can carry huge costs. A rapid depreciation could lead to aggressive capital outflows, triggering even more currency declines. The downward spiral tends to dent appetite for China stocks and bonds, risks destabilizing financial markets and hurting growth.
The world’s second largest economy is already challenged by a prolonged property crisis and souring consumer sentiment. To rejuvenate growth, China earlier this week signaled bolder economic support next year, embracing a “moderately loose” monetary policy and pledging “more proactive” fiscal policy.
The yawning yield gap between Chinese sovereign bonds and Treasuries is also putting pressure on the yuan. China’s 10-year benchmark yield fell to a fresh record low this week, below 1.9%, amid bets on more interest-rate cuts from the PBOC.
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Strategists at BNP Paribas SA see the yuan falling to 7.45 by the end of 2025, according to a note this week, while Nomura said this month the currency can drop to 7.6 in offshore trading by May. JPMorgan Chase & Co. expects the offshore yuan to weaken to 7.5 in the second quarter, according to a research note.
“For any macro trader, this is a case of when and by how much yuan weakens in the first half of next year — and not so much if,” said Viraj Patel, strategist at Vanda Research in London. “When Chinese authorities start ‘mulling’ things over, we all know what comes next.”
Still, economists including Karsten Junius, chief economist at Bank J Safra Sarasin, said that it was “too early” for China to step into the market to weaken the yuan before the US announces any trade restrictions.
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The Reuters report will refocus trader attention on China’s daily reference rate for the managed currency — Beijing’s preferred tool to guide yuan expectations. That’s the gauge around which the yuan is allowed to trade in a 2% range.
The PBOC has consistently set the so-called fixing stronger than 7.2 since the US election, despite wild swings in the greenback and increasing predictions by analysts that the central bank would buckle. Allowing a breach risks sending a signal to traders that the PBOC is comfortable with further yuan weakness, while holding the line suggests it may dig in for a fight.
“A moderate depreciation is an increasingly likely scenario as long as the move is not excessive versus non-greenback currencies,” said Gary Ng, senior economist at Natixis. “However, the market should still be wary of sudden intervention if the move is too big within a short period of time.”
Authorities in Beijing may be open to allowing the yuan to be flexible, said Khoon Goh, head of Asia Research at Australia & New Zealand Banking Group Ltd, but he added that they may not want a premature over-reaction based on speculation.
This will not be the first time that policymakers face the question of whether to prioritize currency stability or boost exports. During the last China-US trade war under Trump’s first administration, Beijing allowed the yuan to weaken past the psychological milestone of 7 for the first time since the global financial crisis.
In August 2015, Beijing devalued the yuan in a shocking move to aid growth and reform its foreign-exchange market. That quickly backfired with capital outflows surging, prompting the central bank to burn through its reserves to stabilize the currency.
This time, Beijing would be mindful of creating too much weakness and volatility in the currency at a time when it wants to increase the yuan’s reserve status, said Foley at Rabobank. “The authorities would be looking for some equilibrium between these factors.”
--With assistance from Iris Ouyang, Naomi Tajitsu and Margaryta Kirakosian.
(Updates prices, adds further context and comment.)
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