Chinese Yuan Steady, But For How Long?

One currency that has continued to strengthen throughout the recent bout of weakness in emerging markets currency markets is the Chinese yuan. This has taken us slightly by surprise, for although China's current account and external surpluses are in better shape than most of the other economies in the region, they are not materially different, and we have seen hot money flow out of China on previous occasions.

The most probable reason for the relative strength of the yuan is that the People's Bank of China (PBoC) is committed to rebalancing the economy and needs a firm currency to support private consumption. The problem that we see the PBoC facing, however, is that exports may drop off sharply over the coming months, as the real effective exchange rate of the yuan has strengthened substantially. This may force a change in policy within the PBoC, which could be forced to talk down its currency, thereby causing it to join the regional sell-off.