SHANGHAI: China’s yuan strengthened to its firmest level against the dollar in more than a week on Wednesday after the central bank set its strongest daily fixing in seven days, and as hopes for Ukraine-Russia peace talks lifted global risk appetite.
But traders said that, with focus shifting away from Ukraine and toward rate hikes and tapering by the US Federal Reserve, and with rising pressure on China’s economy lifting the likelihood of more easing, further strong gains in the currency are unlikely.
“How things go from here will depend on how flows move after the China-US spread inverts,” said a trader at a Chinese bank.
The gap between benchmark China and US 10-year yields edged higher to around 45 basis points on Wednesday after narrowing to as little 18.66 basis points on Monday - close to levels seen in July 2010.
But the spread has already inverted this week at the shorter end of the curve, where a rise in short-term US rates briefly lifted the US 2-year yield above the 10-year yield, , a possible warning sign of a coming recession.
The Chinese 2-year yield now sits below its US counterpart for the first time since the first quarter of 2019, according to Refinitiv.
Yuan firms, but hawkish Fed, capital outflows haunt Chinese assets
Even as the dollar strengthened last year, robust yield premiums on Chinese debt helped to attract capital inflows and lift the Chinese currency.
A switch to outflows could put the yuan under pressure, the bank trader said.
Before the market open, the People’s Bank of China (PBOC) set the yuan’s daily midpoint rate at 6.3566 per dollar, its strongest since last Wednesday though weaker than expectations.
Spot yuan opened at 6.3639 per dollar and firmed to a top of 6.3582 per dollar, its strongest since March 21.
It trimmed gains to change hands at 6.3595 at midday, 40 pips stronger than Tuesday’s late session close.
The offshore yuan also firmed, strengthening to 6.3681 per dollar as the global dollar index fell to 98.117 from the previous close of 98.404.
But few traders or analysts see room for sustained yuan gains as the country’s economic outlook clouds, with China’s most populous city and financial centre, Shanghai, continuing to grapple with a staggered lockdown to contain a local COVID-19 surge.
The city on Wedneday expanded its lockdown earlier than scheduled as it reported a total of 5,982 new local coronavirus cases.
“Chinese consumers and businesses will no doubt be looking for policy support, but so far, few concrete signs have emerged about the form this will take,” said Heron Lim, economist at Moody’s Analytics.
“We expect the People’s Bank of China to cut rates as soon as possible given the downside risks, and China should provide fiscal support if it is to keep the 5.5% growth target for 2022 alive.”
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