After a morning adjustment in short- and medium-term policy interest rates, both the onshore and offshore yuan fell against the U.S. dollar, sparking discussions about the potential increase in devaluation pressures.
On August 15, the yuan's spot exchange rate against the dollar briefly narrowed its decline after breaking the 7.28 mark. However, it resumed its downward trajectory in the afternoon, closing at 7.2868, down 331 basis points from the previous trading day. This was the lowest closing rate in over nine months, specifically since November 3, 2022, when the yuan closed at 7.3200 against the dollar. Entering evening trading hours, the rate continued its descent, approaching the 7.29 mark.
The offshore yuan, which often mirrors international investors' expectations, dropped swiftly on the morning of August 15 after the interest rate cut, breaking the 7.31 mark. It later rose to around 7.29 but fell again, breaking 7.32, a decrease of over 400 points compared to the previous trading day.
The rate cuts have now placed focus on their potential impact on the already weak yuan.
On the morning of August 15, the People's Bank of China (PBOC) announced adjustments: the 1-year Medium-term Lending Facility (MLF) rate was reduced from 2.65% to 2.5%, and the 7-day reverse repo rate was cut from 1.90% to 1.8%, marking decreases of 15 and 10 basis points respectively.
"After today's rate cuts, the offshore yuan fell below 7.3. Since August, as the U.S. dollar index has risen, the yuan has devalued once more. Due to China's loose monetary policies and uncertainties in the Federal Reserve's policy tone, we expect the yuan to fluctuate throughout the third quarter. However, it should serve as a balancer for domestic and foreign influences. We believe that domestic policies won't be significantly impacted," said Li Chao, Chief Economist at Zhejiang Securities.
Li also mentioned he doesn't expect the yuan to devalue continuously within the year. He forecasts a higher probability of appreciation in the fourth quarter, as China's advantages become more prominent when compared to the U.S. economy. Additionally, he anticipates a contraction in U.S. bank credit and depletion of excess reserves in the latter half of the year, which should ease inflation and labor market tensions, further reinforcing expectations for a halt in monetary tightening. Overall, Li expects China to maintain advantages in both fundamentals and monetary policy expectations, propelling the yuan's appreciation.
Orient Securities, in its latest research report, noted that the recent dip in the yuan's value is mainly due to short-term risk events. The sustainability of this trend remains to be seen. They highlighted the richness of the current exchange rate stabilization tools, expressing confidence that timely interventions would guide market expectations and curb any "herd effects" in the exchange market. They also believe that the yuan's exchange rate won't hinder domestic monetary policies. As the world's second-largest economy, China will prioritize maintaining the independence of its monetary policy and will employ policy tools to prevent significant fluctuations in the yuan exchange rate and cross-border capital flows. This perspective suggests that regardless of when the Federal Reserve stops hiking rates, it won't substantially affect China's ability to adjust its monetary policy flexibly. The MLF rate cut in June already demonstrated this.
An FX trader from a joint-stock bank mentioned, "Although today's mid-price still showed a stabilization signal, the MLF rate cut, especially its extent, exceeded expectations. Coupled with the macro data released in July, the spot exchange rate plummeted. What follows will depend on improvements in the economic fundamentals and the direction of the Federal Reserve."
