China seen allowing bigger yuan declines as trade tensions ease

China will probably let the yuan weaken further now that trade tensions with the U.S. are receding and capital outflow pressures are easing, according to Natixis SA and DBS Group Holdings Ltd.

Last week’s meeting between the nation’s presidents has reduced the chances of the U.S. labeling the Asian country a currency manipulator in the near term, said  Alicia Garcia Herrero, chief Asia-Pacific economist at Natixis. Signs of a stabilizing economy are adding to the case for Chinese policy makers allowing bigger moves, according to DBS.

Expectations that the yuan will weaken are showing up in the market, with the offshore yuan headed for the longest stretch of declines since October and a gauge of onshore volatility rising to a one-month high. The exchange rate has weakened 0.5 percent so far this month, after recording its strongest quarter in a year. China’s real effective exchange rate climbed 36 percent in the past 10 years, according to a Bank for International Settlements gauge.

“China is still motivated to depreciate the yuan,” said Hong Kong-based Garcia Herrero. “The U.S. is unlikely to announce China a currency manipulator right after the presidents’ meeting. China has bought time – maybe one year – on the currency manipulation issue.”

Presidents Xi Jinping and Donald Trump agreed on a “100-day plan” to address the two nations’ trade imbalance during a meeting in Florida last week, with investors seeing the outcome as generally positive for bilateral relations.

This came before the U.S. Treasury Department is set to publish a semi-annual report on trading partners’ foreign-
exchange policy as early as this week. Trump has described China as the “grand champion” of manipulation and threatened to impose punitive tariffs on the country’s exports.

The onshore currency’s one-month implied volatility, which is used to price options, rose to 3.97 percent on Monday, the highest since March 10. The yuan will drop 2.5 percent through the rest of this year in Shanghai, according to the median forecast in a Bloomberg survey. China’s capital flows turned positive in February for the first time since January 2015, according to a Bloomberg Intelligence estimate, and foreign-exchange reserves increased for a second straight month in March.

“Against the backdrop of stabilizing growth and a calm outflow picture, China has been more flexible on the yuan’s exchange rate and comfortable to see a bit more depreciation,” said Nathan Chow, an economist at DBS in Hong Kong. “The yuan’s weakness in April also shows the PBOC’s intention to let the yuan become more market-driven in the mid-term.” Bloomberg