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Chinese Yuan Weakens As Investors Bet Beijing Will Rein In Financial Risks

June 12, 2020 at 17:21 by Andrew Moran

Various yuan banknotesThe Chinese yuan is weakening at the end of the trading week, driven primarily by reports that government officials will rein in financial risks and push cheap funding into the real economy. The yuan has had a relatively flat week against the US dollar amid chaos in global financial markets. Where is the currency headed in the second half of 2020? And will the world’s second-largest economy succeed in its reset over the next six months?

The bond market surged on Friday as yields on the benchmark one-year government note climbed to a three-month high of 2.09%. Despite China still trying to recover from the coronavirus pandemic, the repo and swap line rates also climbed double digits.

This comes soon after the People’s Bank of China (PBoC) announced earlier this week that it will not continue to lower the cost of its short-term loans to financial institutions. Last month, it did outline a proposal to buy back loans from banks to encourage small business lending, which would push banks to extend more credit to smaller enterprises. In the coronavirus fallout, this has been a chief concern for the state.

Analysts believe that the purpose behind the PBoC’s recent measures is to prevent investors from utilizing stimulus money to take risky positions in the broader market or to accumulate debt. In the first four months of 2020, there was a collapse in long-term yields that sent the signal that investors were scooping up government bonds.

In what may be a surprise to market observers, the PBoC has permitted a slight increase in interest rates. The central bank excused the move by alluding to a shift in the exchange rate or an adjustment to market risks.

Meanwhile, on the data front, automobile sales advanced at an annualized rate of 14.5% in May, up from the 4.4% gain in April.

On Wednesday, the National Bureau of Statistics (NBS) reported that the inflation rate dropped 0.8% last month, a slight jump from the 0.9% decline in April. The producer price index (PPI) fell 3.7% in May, down from the 3.1% slide in the previous month.

New yuan loan growth fell short of the median estimate, while the M2 money supply remained at an 11.1% pace.

On Monday, housing prices, industrial production, and retail sales data will be released.

The key question in the forex market is now: Where is the yuan headed in H2? Goldman Sachs made headlines when it projected further weakness in the currency, but the Wall Street titan suggested it would not be a freefall comparable to last year. The biggest threat to the yuan is US-China tensions.

Zach Pandl, a Goldman analyst, wrote in a research note earlier this week:

The specific policies [announced by Trump] were relatively narrow in scope, and we would not consider the steps a meaningful escalation. However, disputes between the two countries now cover a range of issues which seem unlikely to be resolved soon, and we expect legislation related to the delisting of Chinese firms to become law.

The USD/CNY currency pair rose 0.26% to 7.0834, from an opening of 7.0650, at 17:09 GMT on Friday. The EUR/CNY tumbled 0.24% to 7.9628, from an opening of 7.9825.

If you have any questions, comments, or opinions regarding the Chinese Yuan, feel free to post them using the commentary form below.

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