The renminbi has remained in a downtrend for much of the year, falling to its lowest levels against the dollar since November 2022. The upward adjustment in US interest rate assumptions has coincided with a faltering post-Covid economic rebound to weaken rate differentials and limit the appeal of Chinese assets. With domestic demand remaining stubbornly anemic, markets are convinced policymakers are preparing to roll out a range of measures – including more rate cuts – to support growth in coming months.

Much like our thoughts regarding the Japanese yen, we believe a lot of negativity may now be built into the exchange rate and that there are asymmetric risks going forward. While some further yuan weakness and volatility could unfold in the near-term, we think the medium-term balance of probabilities increasingly favours a recovery in the currency

EURUSD vs. USDCNY

The yuan and a range of risk-sensitive asset classes could confront a bearish situation if China’s economic rebound continues to stutter along and no substantive support measures are implemented. Weakening domestic growth momentum – at a point when other major economies are facing recession risks – could dampen global growth forecasts and create a negative feedback loop.

If global inflation fails to meaningfully slow, forcing developed-economy central banks to tighten monetary conditions even further, growth projections might fall as interest rate expectations move higher. This could weigh on China’s export outlook and push the dollar higher than expected.

We think a bullish scenario could unfold if authorities unveil a larger and more broad-based stimulus package to prop up the fading economic expansion. In our assessment, a more definitive re-acceleration in China’s growth pulse, particularly across the domestically-oriented services sector, could encourage a recovery in capital inflows as the economy outperforms on a relative basis. Alternatively, a more shallow global slowdown, coupled with a faster and less disruptive deceleration in inflation – which might enable developed-economy central banks to shift away from restrictive policy stances sooner – could be a negative for the US dollar, helping support risk assets and Asian currencies including the yuan.

China activity indicators, annual % change

While China’s emergence from COVID hibernation has underwhelmed relative to bullish projections, we believe policymakers may soon step up their efforts to boost growth and job creation. Youth unemployment is historically high, while consumer confidence is quite low, and external-facing sectors are grappling with a slowing world economy. Based on this mix, and ongoing financial stability concerns, we expect support measures to be aimed at fostering labor-intensive consumption growth. An improvement in the country’s economic fortunes should encourage capital inflows, particularly as it is set to occur when growth momentum across other major economies is slowing.

Diverging growth trends should be Chinese yuan supportive, and we are looking for the currency to stabilize before drifting higher over the third quarter and the following few quarters. We think the currency will push toward the 6.75 mark by mid-2024 as the US dollar loses ground against other major currencies such as the Japanese yen and euro – and to a lesser extent, the Australian dollar.