The last time China’s currency was sinking this fast, investors around the world responded by fleeing riskier assets. Now, they’re taking the declines in stride.
While the yuan has depreciated 1.5% over the past two weeks to the lowest level since November 2010, developing-nation and US equities have held steady over the same period and the VIX volatility index has tumbled. Even the added headwind of Britain’s vote to leave the European Union has failed to derail markets that just six months ago convulsed with every move lower in the Chinese currency.
Global investors are growing more comfortable with a weaker yuan after China’s central bank improved its communication with markets and took steps to prevent a downward spiral of depreciation and capital outflows. HSBC Holdings sees little chance of a return to January’s turmoil, while Beijing Gao Hua Securities Co says the Chinese currency will be stronger against a basket of trading partners by year-end.
“This time, it’s different,” said Song Yu, the Beijing-based chief China economist at Gao Hua, the mainland joint-venture partner of Goldman Sachs Group. He has been the top-ranked forecaster of China’s economy since Bloomberg began its ranking in 2013. “The recent depreciation in the yuan didn’t result in large volatility in financial markets around the world, and there weren’t heavy speculative positions shorting the currency or individuals trying to convert their yuan holdings into the dollar in a panic.”
When the Chinese currency tumbled in January amid eight straight days of weaker yuan fixings by the central bank, the losses contributed to a global stock market selloff and fuelled more than $144bn of capital outflows from Asia’s largest economy. The Shanghai Composite Index posted its biggest monthly slump in seven years, while government borrowing costs rose.
The central bank has since sought to better explain its intentions to investors. People’s Bank of China governor Zhou Xiaochuan told International Monetary Fund managing director Christine Lagarde in June that the government will step up efforts to educate the public about the market, while Premier Li Keqiang encouraged the PBoC to improve communication by holding more press conferences and accepting interview requests.
The central bank research bureau’s chief economist agreed to a rare interview last month to explain how a basket tracking the yuan against 13 other exchange rates works and how the central bank sets its daily fixings, which restrict the onshore yuan’s moves to 2% on either side.
To keep yuan declines from spiralling into a rout, China has also tightened capital controls, intervened in the currency market and waged a verbal campaign to support the exchange rate. Authorities have suspended new applications for China’s main overseas portfolio investment program and increased scrutiny of transactions to send money abroad.
“The market appears to have a better understanding of the current fixing mechanism and appears more able to digest the volatility that accompanies it,” UBS Group strategists including Maximillian Lin wrote in a note on Monday. “We believe better central bank communication has led to a more stable market.”
The calm could be disrupted when global investors turn their attention back to China, after focusing in recent days on the Brexit vote, according to Bjarke Roed-Frederiksen, a Copenhagen-based senior economist at Svenska Handelsbanken. Riskier assets have found support from speculation that Brexit will spur central banks around the world to keep monetary policies accommodative.
“If Beijing continues to weaken its currency, it would soon show up on everybody’s screens, and concerns could return fairly quickly,” Roed-Frederiksen said. He sees the currency sliding to 6.8 per dollar by year-end.
For now, markets in China and elsewhere don’t seemed bothered by the yuan’s weakness. Options traders are pricing in just 15.5% odds that the Chinese currency will drop to 7 per dollar by December, down from 30% in January, data compiled by Bloomberg show. The currency rose 0.2% on Thursday to 6.6800 after the central bank reported an unexpected increase in its foreign-exchange reserves. The Shanghai Composite has gained 4.3% in the past two weeks, while the S&P 500 Index is down 0.6%.
For Wang Ju, a senior foreign-exchange strategist at HSBC in Hong Kong, the subdued reaction to yuan depreciation could convince Chinese policy makers to roll back some of their efforts to restrain cross-border capital flows and push forward on pledges to open up the country’s markets.
“The market has managed to take higher yuan volatility in its stride, which is a strong indication that China’s foreign exchange reforms are moving in the right direction,” Wang said. “This will give Chinese authorities more confidence as they proceed with capital account liberalisation.”