Why the hurdle for a major CNY devaluation remains high

investment insights

Why the hurdle for a major CNY devaluation remains high

Vasileios Gkionakis, PhD - Global Head of FX Strategy

Vasileios Gkionakis, PhD

Global Head of FX Strategy
Homin Lee - Macro Strategist - Asia

Homin Lee

Macro Strategist - Asia

In the wake of the unexpected – and rather intense – re-escalation of the trade dispute between the US and China, many investors are fretting that China might devalue its currency to counter trade-related provocation from the US or create stronger pressures for a compromise. While this appears a reasonable concern, we believe that the hurdle remains very high for such a move. In fact, it is entirely possible (and indeed, more reasonable) for China to opt for the currency’s stability, even if a protracted and difficult bilateral negotiation has become quite a realistic scenario.

Many investors are fretting that China might devalue its currency to counter trade-related provocation from the US

The People’s Bank targets foreign exchange value… not inflation

A key point here is the fact that the People’s Bank of China (PBoC, the country’s central bank) implicitly targets the value of its currency, not inflation. Most central banks that investors are familiar with (e.g. the US Federal Reserve/Fed or the European Central Bank/ECB) target the inflation rate in their economy via market-driven floating exchange rates and minimal restrictions on capital flows. China has neither. The official inflation target adopted by the National People’s Congress every year (3% in 2019) has little to do with the PBoC’s day-to-day operations.

Given this context, a large decline in the value of the yuan would be the outcome of two mutually exclusive scenarios.

  1. PBoC decides to let markets find the fundamental value of the yuan without intervening
  2. PBoC devalues to “re-define” the level of FX it is comfortable with

Read more here

Important information

This document is issued by Bank Lombard Odier & Co Ltd or an entity of the Group (hereinafter “Lombard Odier”). It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a document. This document was not prepared by the Financial Research Department of Lombard Odier.

Read more.