The yuan has also gained ground against the dollar. The yuan has risen between 2.4% and 2.8% against the dollar this year, depending on whether it is traded in China or offshore. Both versions are now at their highest levels against the dollar in three years or more. Offshore interest is currently trading at 6.34 yuan per dollar, a level not seen since May 2018.
Heading into December, this year’s yuan gains were “the best in the world,” said Marc Chandler, president of Bannockburn Global Forex, an Ohio-based capital markets trading firm.
Growing exports and hot money chasing relatively juicy yields on Chinese government bonds are driving the surge “despite weaker economic growth”, according to Becky Liu, China chief of macro strategy at Standard Chartered Bank.
The currency’s strong performance could continue into 2022, even as the Chinese economy struggles with factory inflation, a major slowdown in real estate and an ongoing regulatory crackdown on the private sector.
Liu expects the yuan to strengthen to 6.3 per dollar in the first months of next year. Analysts at Goldman Sachs suggest: the same can happen in the first half of 2022, for similar reasons. (In 2014, the offshore yuan nearly hit 6.01 against the dollar, the highest level since China staged a historic revaluation of its currency in 2005.)
There are benefits to this trend. The stronger the yuan, the more likely central banks are to hold a large portion of the currency in reserve, favoring its global use. It could also help make imports cheaper and curb high inflation. China buys many commodities priced in dollars.
But there is a pretty big downside if the currency appreciates too quickly. Because no matter how strong Chinese exports are at the moment, a more expensive currency can also make those exports less competitive abroad. Given how vital trade has been to the Chinese economy, it could threaten an already fragile recovery.
Strong exports
Nevertheless, Chinese exports held up well. Shipments from China reached $325.5 billion in November, up 22% from the previous year, according to government statistics released Tuesday. Exports during the first 11 months of the year are up 31% to more than $3 trillion – more than in all of 2020.
The main reason for the yuan’s rise is the amount of money flowing in China, thanks in large part to rising exports, said Larry Hu, head of China Economics at Macquarie Group.
Betting big on Chinese bonds
Another Analysts say the reason for the yuan’s rally is international enthusiasm for Chinese bonds.
The value of yuan-denominated bonds held by international investors rose for the eighth straight month in November to 3.9 trillion yuan ($620 billion), according to the People’s Bank of China.
Global investment in Chinese bonds accelerated after FTSE Russell, the global index provider, added Chinese government bonds to its flagship World Government Bond Index in October. That is one of the world’s most widely used global bond benchmarks.
Analysts at ANZ expect the inclusion of China in the index to generate about $130 billion in investment in Chinese government bonds over the next three years. They also estimate that foreign investors will own 4 trillion yuan ($625 billion) worth of Chinese onshore bonds at the end of this year.
“Concerns about downside risks to China’s near-term growth prospects, in our view, will not stop foreign investors from increasing their allocation to Chinese assets,” the analysts wrote in a research report last month.
Global investors are chasing “attractive” Chinese government bond yields, she added. China now offers a 10-year yield of 2.9%, compared to the US Treasury 10-year yield of 1.44%. The ANZ analysts expected those bonds to maintain their appeal, helped by the low volatility of the yuan, which is still not completely free from government intervention.
Stabilizing the yuan’s rise
And Beijing can intervene to curb the rapid appreciation of the yuan.
The People’s Bank of China announced Thursday that it would increase its foreign exchange reserve ratio from 7% to 9% – the second increase in the ratio this year. The move will force Chinese financial institutions to hold more foreign money in reserve, and is widely interpreted as an attempt to dampen the yuan’s rally.
“This is one of the strongest signals” that the central bank is not comfortable with the pace of the yuan’s appreciation, Gaurav Garg and Philip Yin, analysts for Citi, wrote in a report Friday.
The central bank warned last month that financial institutions and companies should refrain from ‘speculative’ bets on the yuan. Analysts said regulators are concerned that if the yuan is too strong it will hurt the competitiveness of Chinese goods around the world. Financial markets can also be disrupted by rapid capital inflows if the currency appreciates too quickly.
“It is desirable for the [yuan] remain largely stable [for] the Chinese authorities, we believe,” said Liu of Standard Chartered.
Still, Liu expected that the chances of China deploying “heavy-handed direct intervention” such as buying dollars directly and selling yuan would remain slim.
One or two rate hikes in the US could also take some of the heat out of the yuan as China moves in the opposite direction with monetary policy in an effort to boost growth.
“We still expect further gains in the yuan, but at a much more gradual pace,” Goldman Sachs analysts wrote in a research report last month, noting that China’s “key trading partners” have begun tightening policies.