China’s trajectory will be an important driver of foreign exchange and broader asset markets over 2024. After the economy suffered some renewed weakness when the COVID-zero policies were rolled back, policymakers in China stepped up their efforts to re-invigorate activity, and there are signs momentum has bottomed out. On top of the monetary easing that has been put through, and the efforts to support the renminbi, targeted fiscal measures have also been unveiled, along with a raft of policies aimed at brightening the outlook in the beleaguered property sector.

USDCNY daily fix vs. survey estimate

Taken individually, the measures don’t appear overly large. But collectively we believe pulling these policy levers can generate a rebound in growth, especially with additional actions probable down the track. Of note: the issuance of local government special bonds has picked up and the budget deficit target has been raised. Greater government borrowing typically foreshadows fiscal spending and infrastructure investment. In our judgement, a bullish case for the renminbi can be made if policymakers keep at it and succeed in engineering a self-reinforcing virtuous cycle within the private sector. A sharper re-acceleration in activity could see the renminbi strengthen more than we are predicting.

China “special” local government bond issuance, trillions yuan, cumulative, calendar year

A bearish scenario for the renminbi could manifest if China’s economy fails to re-ignite. There is a risk that the government’s policy response is not forceful enough to sustainably turn the property market around, awaken dormant animal spirits, and counteract the drag on exports and production within a sluggish global export environment. An extended period of subpar growth might unnerve markets, given the potential financial stability and deflationary risks that could be enflamed. We think this sort of backdrop could accelerate renminbi-negative capital flight out of the country.

China inflation, annual % change

While nominal interest rate differentials may favour the US dollar for some time, we believe this renminbi headwind has topped out. Diverging growth trends should continue to assert themselves as a currency tailwind. In a world economy where recession risks ought to endure for many major economies, a sturdier China should encourage renminbi-positive capital inflows. Our baseline view is that the renminbi gradually strengthens over 2024. When combined with a softening US dollar, we see the exchange rate edging down to 7.05 by mid-2024 before moving sub-7.00 later in the year.

China credit impulse and activity, annual % change