Macroscope | US dollar-yuan divergence trade could spin out of control without intervention from China soon

It’s a dilemma for the government as a weaker yuan might be good news for China’s hard-pressed exporters, but it could also open Beijing up to fresh accusations from Washington of currency manipulation. This would be bad timing, especially after US Secretary of State Antony Blinken’s visit to China this week for talks to help stabilise the fraught relationship between the two nations.

It’s the divergence between rising US interest rates and lower rates in China which is the problem, while the rising spread of US bond yields over China is giving added momentum to the stronger dollar-weaker yuan trade. The worry is there is no end in sight with the US Federal Reserve fretting over inflation while Beijing is more concerned about hitting its 5 per cent growth target for 2023. The dollar-yuan divergence trade could get out of hand quickly without intervention soon.

Last week was a tale of two diverging economies. As expected, the Fed paused its relentless 14-month campaign to stamp out excessive inflation with tougher monetary policy, although it made it clear that it was a hawkish break with the intention of raising interest rates again in the coming months.

On the other side of the equation, Beijing cut one of its benchmark lending rates by 10 basis points to help shore up domestic demand and get the economy back on target for growth of 5 per cent this year. With interest rate expectations heading in different directions, US dollar bulls hardly needed any encouragement. Relative interest rate prospects moving apart means that it’s just a question of how high the dollar-yuan trade can go before the Beijing calls a halt.