How Far Will China Let the Yuan Fall?

The US Federal Reserve Open Market Committee has met and decided to raise interest rates one more time this year and probably twice next year. This will ease the downward pressure on the USD dollar and ease the upward pressure on the yuan versus the greenback. Bloomberg speculates about China’s line in the sand for the yuan. In other words how far will they let the yuan fall?

China’s bid to rein in appreciation pressure on the yuan will get a helping hand from dollar today, and also provide the market with some valuable intelligence.

How far the People’s Bank of China lets the yuan pull back during this session could indicate to traders the level they’re comfortable with right now. The central bank issues a reference rate for the currency versus the dollar each day and allows it to move 2 percent either side of that rate.

While policy makers have supported the yuan’s turnaround this year, which comes after its worst annual loss in more than two decades, there have been signs in recent weeks that they thought the rally may have gone too far.

Although China needs to move toward open markets and a free floating currency that is not going to happen any time soon. So we will need to read the tea leaves of how they respond to currency rate changes caused by the Fed’s actions. The Financial Times writes that China needs to come clean on its policy regarding exchange rates.

Yet again, China’s currency, the renminbi, is under pressure. After three years when it was fighting to keep the currency’s value from depreciating too quickly relative to the dollar, the tide has shifted once more for the People’s Bank of China. Now, as in the decade since it ostensibly delinked the renminbi from the dollar in 2005, the central bank is striving to limit the currency’s appreciation against the dollar.

Policies governing the capital account, which influence fluctuations in the currency’s value, have also come full circle. In the early years of this decade, the government gradually liberalized capital outflows. The hope was that more outflows would reduce appreciation pressures by offsetting the copious sums of money flowing in through trade surpluses and capital inflows.

Then, for the past three years, these policies were reversed as the currency faced depreciation pressures. Concerns about risks to growth and the financial system stoked a spiral of currency depreciation and capital outflows. The central bank tightened up on capital outflows. This initially led to more panic-driven outflows, but eventually the PBoC won the battle.

We recently asked if a stronger yuan helps or hurts China and compared China’s economic and monetary policy to the Bill Murray movie Groundhog Day in which the main character is caught, like China, in an eternal cycle of actions until learning a basic lesson about life. The underlying lesson is that China, like Japan before it, needs to move from a rigidly controlled economy to one governed by market forces and it needs to let its currency float with the market.