China Paces Yuan Gains to Shield Exporters, Curbing Carry Trade

The Chinese yuan’s appreciation since April is unfolding at just the right pace to neutralize any benefits from holding higher-yielding dollars — and puts it on course to hit 7 against its US counterpart by the end of March next year.

While the People’s Bank of China doesn’t divulge its motives, it guided the currency at this pace with fixings that were initially above the market rate and subsequently sought to slow the yuan’s gains. The measured pace discourages domestic traders from borrowing in yuan to buy and hold dollars, while also preventing a sudden and disruptive repatriation flow of money.

The yuan has risen about 1% every 60 days in recent stretches, gaining roughly 3.7% against the greenback year-to-date, Bloomberg-compiled data show. That cancels out a 2.6% return earned via swap contracts between the two currencies. At this pace the yuan will also hit 7 per dollar at the end of the first quarter next year and finish 2026 at between 6.8 and 6.9, assuming the Federal Reserve and the PBOC leave interest rates at the current levels.

The PBOC’s approach “effectively mitigates the risk of a unilateral yuan rally,” said Frank Zhang, founder of Nalan Advisory, an independent foreign exchange consultancy in Beijing. Its core objective appears to be “preventing yuan appreciation from hurting exporters” and limiting losses from exchange-rate swings.

The returns on the trade underscore the balance that the PBOC is facing as it contends with the yuan’s quickening pace of appreciation. It has to walk a fine line: protecting exporters while facing pressure to allow a stronger yuan, both to appease trade partners unnerved by China’s massive exports and to support economic rebalancing.

To manage the pace, the reference rate — which limits onshore yuan trading within a 2% band — has been set weaker than market estimates since late November. State-owned banks also have bought dollars to limit yuan strength, according to traders.

The PBOC didn’t immediately respond to a fax seeking comment.

The strategy has helped to offset the yield differential between the two currencies, neutralizing carry-trade returns. Profit margins from this trade have hovered between 1% and -1% since July, a long stretch unseen since 2015, Bloomberg-compiled data show.

“I think it’s possible that they are managing yuan appreciation just in line with carry,” said Trang Thuy Le, foreign exchange & rates specialist at LGT Bank AG. “When they are allowing the yuan to outperform — even if the pace of USD/CNY move is just enough to offset carry — the notion of yuan outperformance may be enough to drive dollar selling.”

The prospect of Federal Reserve rate cuts may add to Chinese firms’ dollar-selling pressures, with a narrower US-China yield gap likely prompting some unwinding. The yield differential has been a key driver in dollar hoarding by Chinese firms, pushing onshore foreign-currency deposits to rise to a record high of $1.06 trillion as of the end of November.

Stephen Jen, chief executive of Eurizon SLJ Capital warns of risks on both sides for China: a yuan gain that’s too fast, and one that isn’t fast enough. “Rapid yuan appreciation might spook these treasurers into repatriating their dollar hoardings back into the yuan. But at the same time, the longer Beijing waits to guide the yuan stronger, the bigger this pile of ‘snow’ and the higher the ‘avalanche risk’.”

Another key factor for the PBOC is ensuring the exchange rate is compatible with growth. A policy-led nominal appreciation could worsen deflationary pressures without policies to address fundamental economic weakness, said Louis Kuijs, chief Asia-Pacific economist at S&P Global Ratings.

Markets are now watching whether the yuan will break the key psychological 7-per-dollar level. Settlement flows are orderly but if the yuan rallies past 7.0, exporters will likely ramp up selling in the dollar, said Liu Yang, general manager of the financial market business department at Zheshang Development Group.

“Current FX policy is a prudent choice,” he said. “Stability in the exchange rate and expectations provide certainty for financial markets and manufacturing.”