By Jamie McGeever
ORLANDO, Florida (Reuters) -It’s safe to say that the timing and scale of the stimulus measures unleashed by China this week were driven, in large part, by the U.S. Federal Reserve’s massive interest rate cut just a few days before.
But unfortunately for Chinese authorities, the US central bank’s apparent commitment to an aggressive easing campaign – and the impact this could have on the yuan-dollar exchange rate – could put Beijing in a serious bind.
At first glance, the yuan’s substantial appreciation against the dollar in the two months through Monday was disconcerting. While an increasingly gloomy domestic economic outlook knocked Chinese stocks and bond yields lower, the yuan hit a 16-month high.
And then the yuan got another boost this week, when Beijing rolled out a series of fiscal, monetary and liquidity stimulus measures worth trillions of yuan. It has climbed the barrier of 7.00 per dollar for the first time since January 2023.
This last whistle makes more sense. Investors are betting that Beijing is finally taking the serious steps needed to revive growth. It is notable that the yuan’s rally this week has been accompanied by a rise in stocks and higher bond yields.
In the long term, a strong currency is good news for China. It will boost foreign investor sentiment and attract capital inflows, while raising China’s nominal GDP denominated in dollars, a metric that Beijing will need to focus deeply on if it ever wants to truly rival or even surpass the United States.
In that sense, China’s nominal annual GDP growth rate right now is lower than that of Japan and the United States, something few would have predicted just a few years ago.
But the short-term outlook is more complicated. As growth slumps and deflationary forces intensify, the last thing the Chinese economy needs is a strong exchange rate. Officials will welcome renewed optimism around China, but not the strong currency it generates.
Stephen Jen, co-founder of hedge fund Eurizon SLJ and a long-time China watcher, believes Beijing is caught between a rock and a hard place. As the Fed’s easing cycle progresses, the dollar’s floor against the yuan will almost certainly fall.
“I still believe it will go down, possibly 10% in the next year. Almost everyone is on the wrong track. The positioning adjustment will make this possible decline non-linear,” he wrote on Wednesday.
LIMITED OPTIONS
The People’s Bank of China is obviously powerless to stop the Federal Reserve from slashing US rates. So if the People’s Bank of China wants to avoid an overvaluation of the yuan, it could reduce China’s various lending interest rates or initiate a bond-buying or “quantitative easing” program.
But you have limited scope to do the former, and even less desire to do the latter. That being the case, you could use another tool to prevent the exchange rate from overheating: buying dollars.
However, this plan carries a high political risk. China and the United States are in a trade war that has escalated significantly in recent years. This has deepened the political divide between the two superpowers, which is why China has reduced its holdings of US Treasuries.
China’s official stock of US Treasuries has fallen 30% from a post-pandemic high of $1.1 trillion in early 2021. Its overall holdings of dollar-denominated assets haven’t shrunk that much, but the direction of travel It’s clear. Increasing purchases of U.S. currency and government debt would likely be a difficult sell for Beijing domestically.
What’s more, the incoming US presidential administration, whether led by Kamala Harris or Donald Trump, would almost certainly oppose what it would almost certainly allege is currency manipulation. Retaliatory measures would likely follow, perhaps in the form of even more punitive tariffs.
In other words, Beijing can no longer consider bursts of currency intervention as a reliable default strategy.
So while the measures taken this week may have put China back on the path to a long-term recovery, its currency dilemma could ensure that the going is rocky in the short term.
(The views expressed here are those of the author, a Reuters columnist.)
(By Jamie McGeever; Editing by Andrea Ricci)