HONG KONG—China’s currency has dropped to its weakest level against the U.S. dollar in two years. It is likely to depreciate further as the country’s central bank moves to combat a slowing economy and a deep housing downturn.
On Tuesday, the yuan traded at more than 6.86 to the dollar in China’s tightly controlled onshore market, hitting levels last seen in August 2020, according to FactSet. The currency weakened past 6.88 in the more freely traded offshore market, taking its year-to-date decline against the dollar to more than 8%.
The latest selloff in the yuan, also known as the renminbi, was partly a result of the U.S. dollar’s continued march higher. It was also fueled by a series of recent data releases that appeared to show China’s economy in poor health. Factory output, investment, consumer spending and youth employment numbers in July all pointed to broad economic weakness.
Last week, the People’s Bank of China surprised the markets with 0.1 percentage point cuts to two key interest rates, actions aimed at stimulating more lending activity. On Monday, large commercial banks in the country followed suit with cuts to their lending rates, including a widely referenced benchmark for mortgages.
On Aug. 19, the central bank also signaled its preference for a weaker yuan by setting its daily midpoint for onshore trading, known as the fix, at more than 6.80 against the dollar—the first time it had crossed that level in 23 months. The PBOC allows the currency to trade within a daily range of 2% up or down against the dollar from its target level.
“There was a psychological impact there because 6.80 has held for quite a long time,” said Yuting Shao, a macro strategist at State Street Global Markets. “Where is the upper band now? People are still trying to figure that out.”
On Tuesday morning, the central bank set the midpoint at more than 6.85 yuan to the dollar. A weaker currency helps China’s exporters by making their goods cheaper. But it creates another headwind for foreign investors in stocks and bonds in mainland China by eroding their value. So far this year, international institutions have pulled more than $82 billion from yuan-denominated bonds, a record outflow for the asset class.
The Chinese central bank’s rate cuts have been more detrimental to the yuan’s value against the dollar because the U.S. Federal Reserve has gone in the opposite direction.
The Fed raised its benchmark rate by three quarters of a percentage point in both June and July, marking its most aggressive campaign of rate increases since the 1980s. Traders are divided about whether the Fed will do the same at its next meeting in September, or whether it will settle for a half-percentage point increase. The market is awaiting a speech by Fed Chairman
at a gathering of economists in Jackson Hole, Wyo., this Friday, for clues about which way the central bank is leaning.
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The Fed’s tightening cycle has triggered a widespread selloff in Asian currencies this year, including more than 10% declines for the Japanese yen and the Korean won.
The yuan has also been hard hit, but it has found more support than other currencies as traders have bet on the long-term health of China’s economy, said Chaoping Zhu, global market strategist at J.P. Morgan Asset Management.
That economic argument has now become less compelling. China’s economy contracted by 2.6% in the April-to-June quarter from the first quarter of the year, official data released last month showed. The struggles of the country’s property developers, weakening consumer confidence and the impact of a strict zero-Covid policy are all hampering its recovery prospects.
That means that the two biggest drivers of currencies—interest-rate differences and economic growth projections—both paint a pessimistic picture for the performance of the yuan against the dollar.
China’s central bank is unlikely to cut interest rates again “for the time being,” but it will attempt to increase the money supply, said Gary Ng, a senior economist at Natixis. There are various methods it can use to do that, including cutting the reserve requirement ratio charged to banks, he said. On Monday, the central bank sold 25 billion yuan, equivalent to $3.65 billion, of bills in Hong Kong, slightly reducing the amount of offshore yuan liquidity.
Many analysts are expecting the yuan to weaken further. Mr. Ng at Natixis said he thinks the yuan will reach 6.95 against the dollar this year, largely because of the difference in interest rates between China and the U.S. HSBC’s Joey Chew is expecting the yuan to hit 6.90. Analysts at Bank of America and RBC are predicting 7 yuan to the dollar by 2023.
China’s central bank last let the yuan depreciate past 7 to the dollar in August 2019, during a period of high trade tensions between Beijing and Washington. That move didn’t result—as some had feared—in big capital outflows, but yuan weakness has previously been a bad omen for global markets.
In 2015, a huge stock market selloff in China contributed to a rapid weakening of the yuan, particularly after the PBOC devalued the currency and said it would let the market have a greater say in its future value. Global stock markets reeled and Asian currencies—which often follow the broad trend of the yuan—tumbled along with it.
The yuan has held up better against other currencies this year. China Foreign Exchange Trading System, an arm of the central bank, measures the performance of the currency against a basket of 24 currencies, including the dollar, yen and euro and lesser-traded currencies such as Polish zloty and Russian ruble. That yuan index was roughly at the same level it was at the start of 2022, according to the most recent data published on Aug. 19.
—Rebecca Feng contributed to this article.
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