(Bloomberg) -- China’s ironclad grip on the onshore yuan is leading to an unintended side effect.
In a potential pitfall for exporters, the yuan has surged to the strongest level since October 2022 versus a basket of trading partners’ exchange rates, according to a Bloomberg tracker of the CFETS Index.
The outperformance came as the People’s Bank of China sought to put a floor under the onshore yuan at 7.3 per dollar since December. Still, the yuan breached that level Friday, weakening to as much as 7.3174.
While China’s active defense of the yuan may support its assets, it makes Chinese goods more expensive at a time when US President-elect Donald Trump is threatening more tariffs. Trying to artificially maintain market stability may also lead to outbursts of volatility and erode the effectiveness of policy easing.
“One of the ways monetary policy easing works is through a weaker exchange rate,” said Alvin T. Tan, head of FX strategy at the Royal Bank of Canada in Singapore. “So if the exchange rate is rising instead, it means less effective monetary policy easing, which complicates China’s efforts to improve its economic outlook.”
The PBOC’s steady fixing has helped in pushing down the onshore yuan’s two-week historic volatility to about 0.6% this week, the lowest since July. But that may mask troubles ahead.
“There will be a spike in volatility once the level breaks,” said Mingze Wu, currency trader at StoneX Financial Pte Ltd.
The yuan remains under pressure given uncertainties in the Federal Reserve’s interest rate path, Trump’s tariff policy and lingering risks from the Chinese economy, he added.
A tumble in China’s benchmark yield has also led to a wide rate discount to the US, contributing to pressure on the yuan.
The PBOC turned to the so-called fixing — which limits trading onshore to a 2% range on either side — at 7.1878 per dollar on Friday, stronger than forecast in a Bloomberg survey. State banks also have sold dollars occasionally to prevent the yuan’s decline.
The authorities’ resolve to maintain the currency red line will soon face tests after Trump returns and works on his vow to raise tariffs on Chinese goods to 60%.
The market’s reading so far is less than sanguine. Chinese stocks posted their worst start to a year in nearly a decade while government bonds rallied.
The PBOC might loosen its grip over the fixing if the dollar keeps rallying or if there is more clarity on Trump’s trade policy plans, Tan said. “I think the resulting economic weakness should nudge the PBOC to allow for more FX depreciation.”
(Updates with yuan’s price move in third paragraph.)
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