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US dollar strength just means renminbi bulls need to look further afield for yields

November 16, 2021 GMT

The US dollar has been on the rise, and circumstances currently favour it even against the yuan. Yet, renminbi bulls need not draw in their horns but should, instead, look elsewhere. There are plenty of other currencies against which the renminbi could strengthen while the prospects for yuan depreciation versus the US dollar are limited.

Last week saw the value of the US dollar against a basket of currencies hit its highest level since July 2020. This broad-based appreciation was driven by several factors, not least a continuing rise in the US consumer price index (CPI).

Data released on November 10 by the Bureau of Labour and Statistics showed year-on-year US CPI in October at 6.2 per cent, the biggest rise since December 1990.

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The Federal Reserve’s view that US inflationary pressures are transitory, and do not justify a faster pace of monetary policy tightening, looks increasingly unsustainable, especially with concern growing in the White House and among Democrats on Capitol Hill about the trajectory of American consumer prices.

Markets are beginning to think the Fed will be compelled to respond, and accelerate the tapering of its monthly asset purchase programme, perhaps even bringing forward the timing of an interest rate increase. This notion is underpinning broad US dollar strength on foreign exchanges.

That is not to say inflation is purely a US problem. It is a global issue, with worldwide demand for goods and services rebounding from the slump caused by the Covid-19 pandemic. However, supply chains that were disrupted are not yet fully restored, let alone fit to meet burgeoning demand.

China has a problem with factory gate inflation. Its year-on-year producer price index for October rose by 13.5 per cent, though China’s CPI was only 1.5 per cent on an annualised basis last month. Although that was a big spike from September’s 0.7 per cent, it was well below the US’ October headline consumer inflation figure.

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Meanwhile, all the way down the yield curve to 30 years, nominal yields on US Treasuries are below America’s CPI. As such, once adjusted for inflation, US government bond real yields are negative.

In contrast, the nominal yields on Chinese government bonds are not only above their US equivalents but also above China’s October CPI, providing investors with a positive yuan-denominated real return.

It worth bearing in mind that, as an exporting giant, there will always be a queue of Chinese manufacturers wishing to exchange received US dollars for yuan. In these circumstances, there is arguably limited upside for the US dollar to rise against the renminbi, even if broader market sentiment favours the greenback.

But it also means that, if general foreign exchange sentiment is currently pro-US dollar, yuan bulls might do well to look to pastures new when seeking opportunities to benefit from renminbi appreciation.

There are also rising prices in Europe. Euro-zone year-on-year CPI was 4.1 per cent in October, its highest since July 2008. Even so, the European Central Bank (ECB) still has a benchmark deposit facility interest rate of minus 0.5 per cent and remains committed to existing asset purchase programmes.

It is perhaps also worth noting that Jens Weidmann, long regarded as a rate hawk on the ECB’s Governing Council, is leaving with more than five years left of his eight-year term as president of the Bundesbank, Germany’s central bank. His departure will be effective from December 31, and he is relinquishing his ECB role at the same time.

Against this backdrop, the currency markets might see further downside risk for the euro against the US dollar. This might well also feed through into euro depreciation versus the Chinese yuan.

With Britain’s CPI far above the Bank of England’s benchmark base rate of 0.1 per cent, and Bank of England policymakers voting 7-2 to keep that rate unchanged at its November 4 meeting, it is equally not hard to grasp why markets might see room for both the US dollar and the renminbi to make gains against the pound.

Then there is the Japanese yen. Bank of Japan monetary policy settings remain resolutely ultra-accommodative. With market sentiment broadly pro-US dollar, the outlook for the yen might consequently prove bleak against both the US currency and the yuan.

Foreign exchange market sentiment might currently back the US dollar, but that does not mean there are no opportunities for the yuan to appreciate against other currencies. Renminbi bulls just need to look further afield.

Neal Kimberley is a commentator on macroeconomics and financial markets

This article originally appeared on the South China Morning Post (SCMP), the leading news media reporting on China and Asia. For more SCMP stories, please download our mobile app, follow us on Twitter, and like us on Facebook.

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