Yuan rallies to five year highs as US-China deal on trade gathers momentum

Capital outflows from China are rising on fears of a weakening yuan, a new report by IIF says. AFP 

The yuan’s gains this week, it’s largest since 2005, may offer the best clue yet that China and the US are nearing a deal on trade.

As investors try to assess comments from officials following three days of talks between the two sides in Beijing, Chinese authorities have allowed the currency to climb to a five-month high. That’s a stark contrast to moves last year when investors feared they would deliberately weaken it to pressure the US in negotiations.

The yuan appreciated 1.8 per cent against its US counterpart this week, reaching 6.7400 per dollar, its strongest level since July. The Federal Reserve’s shift to pause mode has helped the currency defy a deepening slowdown across the world’s No. 2 economy -- the Bloomberg Dollar Spot Index tumbled 0.9 per cent in the same period, its worst weekly performance in almost a year.

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“The premise is that Beijing’s policy makers would cap dollar-yuan below 7 in an effort not to further antagonize US-China trade relations,” Claudio Piron, co-head of Asia FX and rates strategy at Bank of America Merrill Lynch in Singapore, said in a report this week.

China described the three-day meetings with US counterparts as “extensive, in-depth and detailed,” laying the foundation for a resolution to the trade conflict. Presidents Donald Trump and Xi Jinping have given their officials until March 1 to reach an agreement on “structural changes” to the Chinese economy. Vice Premier Liu He is set to visit Washington on January 30 and 31 for further trade talks, according to people familiar with the plans.

Last year, escalating trade tensions with the US and looser monetary policy aimed at helping China’s slowing economy had investors wondering whether Chinese authorities would let the yuan drop past 7 per dollar for the first time since 2008. It weakened as far as 6.9780 per dollar on October 31 before signs of easing tension between the two nations sparked a turnaround.

The yuan’s strong performance so far this year also stands in sharp contrast to China’s deepening economic woes. A December manufacturing gauge dropped below 50 -- the level that denotes contraction -- to its weakest since early 2016. The latest price readings were well short of estimates, rekindling deflation fears and leaving more room for the central bank to cut interest rates, Citigroup said in a note to clients on Wednesday. And the prospect of lower rates, in turn, may suggest the yuan should be slumping.