Where Is The Chinese Yuan Headed? (MCHI)

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July 25, 2018 6:13am NASDAQ:MCHI

From BlackRock: Richard Turnill explains why we expect a moderate yuan depreciation in the short term.

The Chinese yuan has been weakening-triggering fears of a sharp devaluation that could roil global markets. Should markets be worried? We see scope for the yuan to moderately depreciate through the rest of the year in response to slower growth, financial deleveraging and escalating trade tensions. The Chinese authorities are likely to rely on monetary and fiscal policy tools, rather than the currency, to manage any growth slowdown in the second half, in our view.

China FX reserve vs Yuan Exchange Rate

The yuan has slid 4% so far this year, with the fall accelerating since mid-June when U.S. President Donald Trump announced a 25% tariff on $50 billion of Chinese imports. See the blue line in the chart above. Yet we do not see China resorting to a 2015-style devaluation to cushion the blow (The yuan fell 2.75% over two days in August that year). Back then, a lack of market confidence in China’s policy framework contributed to capital flight (see the green bars), spooking global markets. Today, China has stricter capital controls in place-and improved coordination between policymakers. We believe this should give the government confidence to allow the yuan to gradually slide lower.

Read more in our Weekly commentary

Slow and steady

The recent tumble in the yuan and China’s stock market has stoked fear: A 2015-style rapid depreciation could spark big capital outflows and another rout in global markets. Yet we expect the Chinese authorities to let the yuan gradually depreciate in a controlled manner through the year end. A moderately weaker yuan may lend a hand to Beijing in its balancing act: seeking to keep the economy humming, while cracking down on financial leverage and cushioning the impact from escalating trade actions. It could boost exports, mitigating blows from reduced domestic investment as a result of the deleveraging campaign. Other factors are weighing on the yuan. U.S. dollar strength is one. Diverging monetary policies in China (easing) and the U.S. (tightening) are another.

The policy, regulatory and growth dynamics in China today are different from 2015. Authorities have become more coordinated in their approach to fiscal, monetary and FX policies; China’s economy is in a better place-and so is the global economy. Beijing has policy tools at its disposal to prop up the economy, with potential for more monetary easing and fiscal spending in the second half. The People’s Bank of China’s (PBoC) recent move to boost market liquidity is one such example. We also take comfort in the PBoC governor’s pledge not to use the currency as a weapon in potential trade wars. A sharp yuan depreciation would undermine Beijing’s deleveraging effort, by driving capital flight and further tightening domestic financial conditions, in our view. It could also fuel inflation and dampen foreign investors’ growing interest in China’s domestic stock and bond markets.

Bottom line

We see moderate yuan depreciation ahead, but are aware of rising risk from trade actions. (See our BlackRock geopolitical risk dashboard for more). We like selected opportunities in emerging market (EM) Asia equities, including China, as we think these risks are largely priced in and have resulted in attractive valuations. We see the gradual addition of China A-shares to global equity indexes as opportunities for global investors to gain exposure to China’s consumer market. We are neutral on rates and credit in China.

Richard Turnill is BlackRock’s global chief investment strategist. He is a regular contributor to The Blog

The iShares MSCI China Index Fund (MCHI) was unchanged in premarket trading Wednesday. Year-to-date, MCHI has declined -2.89%, versus a 5.95% rise in the benchmark S&P 500 index during the same period.

MCHI currently has an ETF Daily News SMART Grade of A (Strong Buy), and is ranked #1 of 38 ETFs in the China Equities ETFs category.

This article is brought to you courtesy of BlackRock.

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