As China grapples with an economic downturn, doubts linger over whether recent fiscal and monetary interventions will spark sustainable growth or alleviate deep-seated sectoral challenges. Investor optimism has weakened amid a lack of detail on new economic measures, while geopolitical risks—particularly the looming US presidential election—could soon further strain the Chinese yuan. With trade tensions potentially poised for resurgence and the Federal Reserve expected to ease rates, the path forward for the USD/CNY pair remains complex and highly contingent on both domestic and international pressures.
The macroeconomic backdrop still limits the yuan's upside potential
The Chinese economy is not out of the woods yet. We remain sceptical about whether the latest coordinated fiscal and monetary easing will sustainably lift activity, lead to robust and broad-based growth, or address the underlying sectoral issues. GDP is expected to rise by nearly 5 pct y/y in 2024, followed by a 4.5 pct increase the following year. Although targets will be met, growth concentrated around fixed asset investment in the manufacturing sector may fail to boost consumer confidence.
Reluctance to take on new loans among corporations and households is deeply entrenched, and banks exhibit a low-risk appetite for funding new housing projects as real estate prices continue to plummet. As a result, the recent market euphoria may prove excessive and unwarranted. Following significant capital inflows, investors have been disillusioned by the lack of details on the new measures. They are likely to remain cautious, waiting to see how the ramp-up of support for the ailing economy will play out. Consequently, cyclical factors still remain negative, limiting the CNY's upside.
US elections present a binary risk for the CNY
We are facing a binary risk event: the US presidential election. The race in swing states is extremely close, but Trump appears to be pulling ahead of Harris. Betting markets currently give the Republican candidate a 59 pct chance of winning. A potential increase in general tariffs on Chinese imports—from an average of 10 pct to as high as 60 pct—in the aftermath of Trump's return to the White House would add to the bearish outlook for the Chinese yuan through the trade channel, which has recently performed well.
The so-called "Trump trade" is back on track; however, the most recent recovery of the US dollar is attributed primarily to the repricing of monetary policy expectations. As recession fears have subsided, markets have priced out approximately 50 basis points of Fed rate cuts in the six-month horizon. Putting politics aside, the USD appears stretched following its recent rally. With the FOMC likely to reduce borrowing costs to below 3.5 pct next year, the interest rate differential will narrow significantly, helping the USD/CNY rate once again grind lower toward the 7.0 mark despite ongoing Chinese economic challenges.
The USD/CNY pair risks skewed to the upside
The CNY is a low-volatility currency. One-month historical volatility has not exceeded 6 pct (annualized) since the first quarter of 2023. While trade tensions and uncertainty could lead to more disorderly movements and higher volatility, the People's Bank of China's tight FX management is unlikely to change, and policymakers' efforts to ensure yuan stability are expected to continue. We see no signs of increasing tolerance for a weaker yuan either.
Bolder calls for the direction of the CNY in 2025 will probably have to wait until January, once the dust settles after the US election. Conotoxia's fintech baseline scenario remains unchanged: we expect a methodical, orderly drift of the yuan higher as the currently unfavourable rate differentials narrow. Over the next year, we anticipate it trading around the 7.0 mark against the US dollar. In the short term, however, the recent upswing—which has retraced about half of the yuan's earlier appreciation—is likely to continue. The USD/CNY pair has so far rebounded nearly 2 pct from its September lows, and we project it will trade around 7.15 by year-end. That said, risks remain skewed to the upside, particularly in the event of a Republican sweep, which could reignite trade tensions.
This commentary is not a recommendation within the meaning of Regulation of the Minister of Finance of 19 October 2005. It has been prepared for information purposes only and should not serve as a basis for making any investment decisions. Neither the author nor the publisher can be held liable for investment decisions made on the basis of information contained in this commentary. Copying or duplicating this report without acknowledgement of the source is prohibited.
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18 Oct 2024 12:00
EUR/USD drills lower as ECB cuts and US retail sales beats estimates
As China grapples with an economic downturn, doubts linger over whether recent fiscal and monetary interventions will spark sustainable growth or alleviate deep-seated sectoral challenges. Investor optimism has weakened amid a lack of detail on new economic measures, while geopolitical risks—particularly the looming US presidential election—could soon further strain the Chinese yuan. With trade tensions potentially poised for resurgence and the Federal Reserve expected to ease rates, the path forward for the USD/CNY pair remains complex and highly contingent on both domestic and international pressures.
The macroeconomic backdrop still limits the yuan's upside potential
The Chinese economy is not out of the woods yet. We remain sceptical about whether the latest coordinated fiscal and monetary easing will sustainably lift activity, lead to robust and broad-based growth, or address the underlying sectoral issues. GDP is expected to rise by nearly 5 pct y/y in 2024, followed by a 4.5 pct increase the following year. Although targets will be met, growth concentrated around fixed asset investment in the manufacturing sector may fail to boost consumer confidence.
Reluctance to take on new loans among corporations and households is deeply entrenched, and banks exhibit a low-risk appetite for funding new housing projects as real estate prices continue to plummet. As a result, the recent market euphoria may prove excessive and unwarranted. Following significant capital inflows, investors have been disillusioned by the lack of details on the new measures. They are likely to remain cautious, waiting to see how the ramp-up of support for the ailing economy will play out. Consequently, cyclical factors still remain negative, limiting the CNY's upside.
US elections present a binary risk for the CNY
We are facing a binary risk event: the US presidential election. The race in swing states is extremely close, but Trump appears to be pulling ahead of Harris. Betting markets currently give the Republican candidate a 59 pct chance of winning. A potential increase in general tariffs on Chinese imports—from an average of 10 pct to as high as 60 pct—in the aftermath of Trump's return to the White House would add to the bearish outlook for the Chinese yuan through the trade channel, which has recently performed well.
The so-called "Trump trade" is back on track; however, the most recent recovery of the US dollar is attributed primarily to the repricing of monetary policy expectations. As recession fears have subsided, markets have priced out approximately 50 basis points of Fed rate cuts in the six-month horizon. Putting politics aside, the USD appears stretched following its recent rally. With the FOMC likely to reduce borrowing costs to below 3.5 pct next year, the interest rate differential will narrow significantly, helping the USD/CNY rate once again grind lower toward the 7.0 mark despite ongoing Chinese economic challenges.
The USD/CNY pair risks skewed to the upside
The CNY is a low-volatility currency. One-month historical volatility has not exceeded 6 pct (annualized) since the first quarter of 2023. While trade tensions and uncertainty could lead to more disorderly movements and higher volatility, the People's Bank of China's tight FX management is unlikely to change, and policymakers' efforts to ensure yuan stability are expected to continue. We see no signs of increasing tolerance for a weaker yuan either.
Bolder calls for the direction of the CNY in 2025 will probably have to wait until January, once the dust settles after the US election. Conotoxia's fintech baseline scenario remains unchanged: we expect a methodical, orderly drift of the yuan higher as the currently unfavourable rate differentials narrow. Over the next year, we anticipate it trading around the 7.0 mark against the US dollar. In the short term, however, the recent upswing—which has retraced about half of the yuan's earlier appreciation—is likely to continue. The USD/CNY pair has so far rebounded nearly 2 pct from its September lows, and we project it will trade around 7.15 by year-end. That said, risks remain skewed to the upside, particularly in the event of a Republican sweep, which could reignite trade tensions.
See also:
EUR/USD drills lower as ECB cuts and US retail sales beats estimates
USD trades firm as hopes for aggressive rate cuts fade
The Swiss National Bank cuts must rely on FX interventions to dent the strength of the franc
US dollar rate without new lows after sharp Fed rate cut; EUR/USD pair stays below the 1.12 handle
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