Investors Brace for Gradual Yuan Weakening in 2025 Amidst Trump Tariff Threat

Investors are bracing for a gradual depreciation of the Chinese yuan against the US dollar in 2025, as reported by Nikkei Asia. This comes as the People's Bank of China (PBOC) faces pressure to defend the currency, driven by rapidly falling domestic interest rates and the looming threat of tariffs under President-elect Donald Trump.

Despite recent policy statements emphasizing the central bank's determination to maintain a strong yuan, traders are already capitalizing on depreciation pressure. The onshore yuan fell to 7.3328 per US dollar on January 10, the weakest level since September 2023, extending its 2.9% slide against the dollar in 2024. This marks the third consecutive year of decline for the tightly managed currency.

The PBOC has kept its reference rate relatively unchanged in recent weeks, bringing the yuan close to the lower limit of its 2% trading band. However, the central bank's recent policy pronouncements suggest a firm stance on currency stability. In its quarterly meeting in late December, PBOC officials vowed to "enhance the resilience of the foreign exchange market," "strengthen market management," and "firmly crack down on disturbing market behaviors." This tone is more assertive than its previous meeting in September, where the focus was on "enhancing the flexibility of the exchange rate."

The yuan's slide has been fueled by a stronger dollar since Trump's election victory, driven by expectations of inflationary policies such as trade tariffs and tax cuts. The sensitivity of the issue was highlighted when a media report suggesting tariffs would only apply to specific sectors prompted a rally in the yuan, only to reverse when Trump denied the report on social media.

China's rapidly falling government bond interest rates, fueled by expectations of further monetary easing to support the economy, have added pressure on the yuan. The yield on the 10-year treasury bond fell below 1.6% on January 3, just a month after breaking the 2% threshold for the first time in at least two decades. Meanwhile, the US Federal Reserve has signaled a slower pace of interest rate cuts, widening the yield gap between the two countries.

Some analysts believe Beijing will tolerate a weaker yuan, which could help exporters offset the impact of higher tariffs. Daniel Haoyu Wang, CEO of Merit Asset Management, predicts an 8% to 10% weakening of the offshore yuan could offset 25% to 35% of the tariff impact. However, Lynn Song, chief Greater China economist at ING, argues that an intentional devaluation "will be ineffective to mitigate tariffs, as it will likely trigger currency manipulator claims."

Most analysts agree that any depreciation needs to be gradual to avoid fueling capital flight from China, undermining its goal of making the yuan a global currency and escalating trade tensions with the US.

The PBOC has already employed various methods to support the currency, including recently announcing plans to issue central bank bills worth 60 billion yuan ($8.2 billion) in Hong Kong, the largest single issuance ever. Analysts believe this move is aimed at absorbing offshore yuan liquidity and making it more expensive to bet on the currency's decline.

Continued pressure on the yuan may limit the PBOC's ability to implement strong monetary easing policies if economic growth slows further. The PBOC has indicated plans to cut the reserve requirement ratio and interest rates, but these cuts have not yet been implemented.

"If Beijing successfully negotiates a trade deal with Washington, the yuan could see an appreciation," says Charu Chanana, chief investment strategist at Saxo. However, she adds that "sustained strength in the yuan would require a US recession, steeper Federal Reserve rate cuts, and an improved economic outlook for China to close the wide interest rate differential with the US."