Here’s why another drop in the Chinese yuan could send another round of market shocks

China’s onshore yuan fell to its lowest level in more than two years on Monday amid fears of a citywide lockdown in Beijing, and a continued decline in the Asian currency could potentially trigger more shocks. shock waves in the financial markets.

The onshore yuan CNYUSD,
-0.88%

USDCNY,
+0.89%,
which trades in mainland China, fell 0.9% to trade around 6.55 to the dollar – en route to its biggest one-day drop since March 12, 2020, according to Tullett Prebon. The chart below shows how much the Chinese renminbi has weakened, with more Asian currency needed to trade per dollar.

Source: FactSet


Meanwhile, the People’s Bank of China announced it would cut its foreign currency deposit reserve ratio by 1 percentage point, to 8%, starting May 15, to help financial institutions use foreign currency funds. .

“The PBOC’s decision revealed some concern about currency weakness,” said Mazen Issa, senior currency strategist at TD Securities TD,
-0.67%
At New York. “The PBOC decision by itself may not be too significant, unless it is followed by other measures. China’s exchange rate is very tightly controlled compared to many other advanced economies, so you can’t rule out intervention measures.

“Certainly there is a lot of concern that these lockdowns will impact global trade and the combination of that with a lot of tightening outside of China, such as in the US, will perhaps exacerbate the expected slowdown,” he said. said Issa over the phone. . “A weaker currency here could be a signal that the outlook for global growth could deteriorate and have the potential to further destabilize markets.”

Fear of a citywide lockdown in the Chinese capital ricocheted through global financial markets on Monday. The fall in the yuan came as the gauge of the US dollar hit a two-year high on Monday, with the greenback benefiting from a flight to quality by investors.

Meanwhile, stocks sold off around the world: the three major U.S. stock indices DJIA,
+0.16%

SPX,
-0.08%

COMP,
+0.60%
tumbled alongside commodities such as CL00 oil,
-2.68%,
which fell below $100 a barrel on demand concerns. And Treasury yields fell as investors sought the safety of government bonds and weighed whether the amount of monetary tightening they expected from the Fed might need to be reduced.

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In 2015, the PBOC surprised financial markets with back-to-back devaluations of the Chinese currency – in part to address the Asian country’s slowing growth – and the moves rippled through global financial markets as traders worried about a currency war. Such depreciation was designed to enhance the attractiveness of Chinese exports and lead to better growth and trade, in theory.

Now, “there is definitely a risk that we will see further weakening of the yuan, but I don’t think we will see any devaluation,” TD’s Issa said. TD expects the onshore yuan to depreciate to 6.7 to the dollar by the end of next year – recent moves likely to accelerate that timetable, he said.

“We think China will be interested in projecting stability onto its regional Asian peers, and moving towards significant currency devaluation runs counter to that,” he said.

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