China’s yuan just had its best quarter in 12 years

Bloomberg October 2 | Updated on October 02, 2020 Published on October 02, 2020

Employees handle toothbrushes on a production line at the Yangzhou Shuguang Toothbrush Factory in Yangzhou, Jiangsu Province, China   -  Bloomberg

But barriers to the currency’s wider use still remain

The Chinese yuan is drawing attention as a haven from volatility after its best quarter in 12 years.

The onshore renminbi gained almost 4 per cent in the three-month period ending September 30, the most since early 2008, while its offshore counterpart advanced more than 4 per cent. That exceeded traditional Group-of-10 refuges like the Swiss franc and Japanese yen, a remarkable turnaround considering the yuan’s devaluation just five years ago triggered a broad market rout.

China’s success in fighting the coronavirus and its economic fallout has attracted both praise and investment, and fuelled speculation that the yuan could become a new sanctuary for the risk-averse. Of course, the nation still tightly controls its exchange rate versus a basket of currencies, and determines how much money is able to cross its borders — taboo for many international asset managers — but those measures have also stabilised the currency even as price swings pick up elsewhere.

“The offshore yuan has been less volatile throughout this time period and the liquidity in the currency remains quite good relative to many currencies,” Brad Bechtel, global head of foreign exchange at Jefferies, said on Wednesday. “China has done a lot of work on improving (its) capital markets and access to those markets and that is likely to continue, which will improve liquidity and attract capital flows.”

Investors sent the offshore yuan to its highest since May 2019 this week, with the currency rallying as much as 0.8 per cent on Thursday, the most in almost three months. Overseas holdings of Chinese sovereign debt have meanwhile risen 22 per cent this year through August.

Also read: Pimco says dollar’s fall is just starting with Asia FX standing to gain

China is set to be the only major economy to grow this year after the Covid-19 outbreak battered the world’s productivity. Economists surveyed by Bloomberg expect the nation’s GDP to rise 2.1 per cent compared to an estimated drop by 4.4 per cent in the US, where disagreement around further stimulus, fears of a virus resurgence and election risk are damping expectations.

The yuan now often trades as much per day as the franc or sterling, Bechtel said. Trading in the currency grew 41 per cent between 2016 and 2019, with a snapshot of turnover taken by the Bank for International Settlements in April last year showing an average $285 billion-a-day changed hands, just behind volumes in the Swiss currency.

It is having a greater impact on the rest of the foreign-exchange market as a result, with correlation between the offshore yuan and currencies including the pound and Australian dollar strengthening since the start of the pandemic, according to HSBC Holdings Plc.

But despite the yuan’s growing influence, barriers remain to its wider use. While global reserves in the Chinese currency have grown to 2.1 per cent, up from 1.4 per cent two years ago, the dollar remains dominant; more than 60 per cent of holdings are still denominated in the US currency, according to data from the International Monetary Fund.

Also read: Dollar’s nascent revival shows value as haven currency of choice

The yuan also carries more risks than its G-10 counterparts. Not only does China’s managed exchange rate make for policy surprises, such as the devaluation in 2015, investors must also stay savvy to global trade tensions.

“Recent Chinese output data has been reassuring, but this can be linked with state support and pent-up demand from abroad,” said Jane Foley, head of foreign-exchange strategy at Rabobank. “Looking ahead, US-China tensions and trends toward on-shoring make us very cautious.”

Furthermore, the Chinese currency could be vulnerable to volatility ahead of the US elections, according to DBS Banking Ltd.

Political debate will naturally focus on the US-China trade relations, with possible questions over the continuity of the Phase One deal, and whether new trade measures are likely to be considered, said Chang Wei Liang, a macro strategist at DBS in Singapore. “This could stoke tensions, and keep yuan traders wary.”

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Published on October 02, 2020
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