China's Yuan is at 5-Month Low and More to Go

China's yuan is at a 5-month low and has lost 1.9% against the dollar this year as foreign investors withdraw more money from its struggling markets. The currency has fallen from about 6.7 per dollar at the start of 2023 to about 7.24 currently, posting a drop of 5%. Regular inflows from domestic exporters have dried up as local businesses prefer to move their dollars offshore on deposits that earn them 6%, compared with 1.5% on domestic yuan deposits, and simply wait for the exchange rate to improve.

The interest rate differential between the U.S. and China has the most surplus since 2007, and this powerful fundamental fact is enough to explain why Chinese exporters are reluctant to exchange their USD’s back for yuan. It looks like this huge positive yield spread is not going away anytime soon. Even for companies that prefer to keep their dollars at home, even though authorities have capped deposit rates at major banks at 2.8% since last year, there are still other dollar-denominated asset management products that invest in overseas funds.

Judging by the recent array of elevated inflation and solid economic data in the U.S., the Fed's rate cuts are on hold until at least late 2024, and the USD is on the uptrend again. That means it is more likely that the yuan exchange rate will reach 7.3, and at that level exporters will be able to bring dollars home, feeling that the authorities can protect it here. That was roughly the low of the yuan exchange rate in both October 2022 and July 2023. Some investment banks also predict the yuan will weaken to 7.3 per dollar by Q3 this year.