China is not using yuan depreciation as a tool in its trade conflict with the U.S., and will likely step in to avert any disorderly decline, according to Morgan Stanley.
“We don’t expect policymakers to encourage material RMB depreciation,” China economists at the bank, led by Robin Xing in Hong Kong, wrote in a July 1 note, referring to the renminbi, the official name of China’s currency. “The PBOC could step up intervention if depreciation risk intensifies.”
The People’s Bank of China has already signaled that it’s on alert for excessive declines, by setting the yuan’s reference rate on the strong side of what models had predicted last week, according to Morgan Stanley. Strategists at Goldman Sachs Group Inc. also on Friday concluded that the PBOC has been “leaning against excessive depreciation in recent days.”
Morgan Stanley sees the yuan at 6.65 per dollar by the end of September, little changed from the 6.6540 level as of 3:42 p.m. in Shanghai. Its “base case” is for the currency to end the year at 6.6. Others have turned bearish after the recent drop, with ING Groep NV cutting its forecast for the second time in a week, to 7 for year-end.
The lesson of 2015, when China devalued its currency then scrambled to halt capital outflows and expectations for continuous yuan declines, is that “active material depreciation” can endanger financial stability, Morgan Stanley said.
The 3 percent drop in the yuan against the dollar over the past two weeks is in part a retracement of its outperformance from February to mid-June, the Morgan Stanley economists said. That earlier divergence was a function of inflows to China’s bond market, which has become increasingly open to foreign investors and is benefiting from diversification moves by global fund managers.
The recent drop also coincided with weakening in Chinese economic data, and moves by the PBOC to shore up bank lending as a counter to regulators’ crackdown on shadow banking. Trade tensions with the U.S. have driven market players to interpret the PBOC as having shifted its policy stance, Morgan Stanley said.
“The possibility that the market may continue to misinterpret PBOC policy fine-tuning, and subdued sentiment, may lead to overshooting risks” for the currency in the near term, Xing and his colleagues wrote. “If the trade-weighted CNY index were to reverse all the divergence with the dollar from February to mid-June, USDCNY could depreciate another 3 percent or more, to 6.8-6.9,” they wrote, using the ticker for the onshore yuan.
Officials may intervene if the yuan, measured against its trading partners’ currencies, drops more than 0.6 percent to 0.7 percent in one session, Morgan Stanley said. Up to now, the declines have been about 0.5 percent.