Has the Big Yuan Short Finally Arrived?
China is grappling with the same issues that heralded the last big yuan selloff
Chinese markets are in trouble once again.
China’s currency is down nearly 1% from Friday’s close, wiping out the yuan’s gains for the year, after the People’s Bank of China cut reserve requirements for banks over the weekend. Slowing growth and rising trade tensions are pummeling Chinese shares, with the Shanghai Composite entering a bear market Tuesday. And rising defaults are testing the country’s gargantuan debt market.
To investors with a long memory, this may sound uncomfortably familiar. The last big yuan selloff, beginning in mid-2015, was heralded by a historic stock-market collapse, a rash of corporate bond defaults and Chinese monetary easing. China’s currency will probably come under further pressure. But a 2016-style blowout—when the currency dropped 7% over the year—may be avoided.
Big capital outflows have yet to reappear. As in 2015, the U.S. and Chinese central banks are moving in opposite directions, making yuan assets less attractive. Investors owning Chinese rather than U.S. 10-year government bonds pocketed a measly 0.6 percentage-point yield premium in May, the smallest since late 2016. Still, Chinese banks purchased a net $19 billion of foreign exchange in May, compared with sales of more than $100 billion in late 2015—a sign that investors remain relatively happy to hold yuan.
One reason is that investors are more confident in Beijing’s ability to defend the currency, thanks to tough capital controls put in place after the 2015 debacle.
A more compelling reason: The most important yuan-denominated asset, Chinese real estate, is still doing rather well. By late 2015, housing prices in many small and medium-size cities had been falling for 18 straight months. By contrast, Chinese housing prices have gained steam in recent months. And although sales growth has slowed, inventories remain low, helping support the market. As long as Chinese investors can make money gambling on housing—and companies can make money building or selling them—weakness in the stock and bond markets may not be enough to trigger a full-scale stampede out of the yuan.
But foreign investors still look too sanguine on China’s currency. Prices for offshore nondeliverable yuan forwards, used to speculate on the Chinese currency, put it at 6.6 against the dollar one year ahead, only marginally weaker than the current spot price of 6.5.
That sort of complacency looks risky. China is now gradually easing monetary policy, while the Federal Reserve is tightening. Trade tensions are rising, and China posted its first current-account deficit since 2001 in the first quarter. Growth will probably slow further in the second half.
Panic or no panic, a weaker Chinese currency in the months ahead still seems likely.