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Financial markets are signaling that China is permitting a gradual depreciation of the yuan, adjusting to a stronger U.S. dollar as it braces for the potential impact of a second Donald Trump presidency. This outlook reflects the consensus that China is unlikely to use the yuan as a policy tool to counteract expected U.S. tariffs, with analysts believing that a sharp devaluation would harm, rather than benefit, China’s fragile economy.
Gradual Depreciation Expected
From yuan forwards to interest rate derivatives, market indicators show that China is already permitting the yuan to weaken at a steady pace. Investors are anticipating a moderate depreciation of around 5-6% from current levels by the end of the year.
In Trump’s first term, the yuan weakened by more than 12% against the dollar between 2018 and 2020 amid escalating U.S.-China tariffs. With Trump set to begin his second term, he has threatened tariffs of up to 60% on Chinese imports, although some reports suggest a gradual increase in levies.
However, analysts argue that the current economic context differs significantly. The yuan is already weak, China’s economy is fragile, and its exports to the U.S. now represent a smaller portion of its overall trade. A large devaluation, analysts say, would not be justifiable and could further destabilize China’s economy.
Yuan Weakness Amid Economic Concerns
The yuan has recently been trading near 16-month lows against the dollar, reflecting a prolonged decline over the past three years. In 2018, it was valued at around 6.3 yuan per dollar. There are discussions within official circles to allow the yuan to fall to around 7.5 per dollar, representing a 2% drop from current levels. This depreciation would likely stem from widening interest rate differentials between the U.S. and China, which have reached about 300 basis points.
Despite this, analysts like Ju Wang, head of Greater China FX and rates strategy at BNP Paribas, argue that further substantial weakening is unlikely. Wang emphasized that while the dollar is already elevated at approximately 7.3 yuan, breaking this level significantly is not a realistic expectation.
Impact of Trade Surplus and External Factors
The yuan’s depreciation is also constrained by China’s trade surplus, particularly with neighboring countries such as Vietnam, which have become key hubs for the finishing of Chinese-manufactured goods. In previous years, China had to defend its policy of allowing the yuan to weaken, emphasizing that it was not engaging in a “beggar-thy-neighbor” currency devaluation.
According to Wang, “There is a responsibility on China’s side to keep the currency relatively stable because you still enjoy a fairly large trade surplus with the rest of the world.”
PBOC Focus on Stability
The People’s Bank of China (PBOC) has reiterated its confidence in the stability of the yuan, stating that it has sufficient foreign exchange reserves and experience to manage external shocks. The PBOC has emphasized its ability to keep the yuan exchange rate at a reasonable equilibrium level.
Given domestic concerns about the economy, there is also a strong incentive to maintain a stable currency to prevent capital outflows. A significant depreciation of the yuan could drive residents and businesses to convert their savings into U.S. dollars or gold, which the PBOC wants to avoid.
Ensuring Financial Stability
Despite the currency’s recent weakness, the trade-weighted CFETS yuan index, which measures the yuan against a basket of 25 currencies, remains close to its highest level in over two years. This indicates that, in relative terms, the yuan has remained stable compared to its trading partners’ currencies.
To support this stability, the PBOC has suspended bond purchases, encouraged companies to borrow abroad to attract more dollars back into China, and often set a stronger yuan trading band than market expectations. While China’s leaders have pledged to loosen monetary policy in 2025 to support economic growth, market expectations suggest that interest rate cuts are unlikely, as the PBOC will prioritize yuan stability.
Outlook for the Yuan
China’s focus will likely remain on maintaining stability, with analysts such as Alpine Macro’s Yan Wang suggesting that the upper limit for the yuan could be around 7.7 per dollar, implying a further 5% depreciation. Despite short-term pressures on the yuan, experts believe that the PBOC will manage the situation carefully to avoid destabilizing the trade-weighted yuan.
“Yuan pressures in the near-term may be hard to avert,” said Vishnu Varathan, head of macro research for Asia ex-Japan at Mizuho, “but it may be managed such that trade-weighted yuan stability is not unduly compromised.”
($1 = 7.3317 Chinese yuan renminbi)
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