The Concerns Regarding Fed Policy and China’s Currency

150812124129-yuan-notes-1024x576Financial markets have started to factor in a higher probability of an interest rate increase in the US this summer. The resulting revival in the US dollar has once again placed the focus on China’s currency (the Renminbi).

In the first week of June 2016, the central bank in China fixed the daily reference rate at the least point in five years.

There are growing concerns that the expected Fed tightening (though modest) and the forecast of higher interest rates in the US are likely to test markets and the determination of China’s central bank in managing its currency policy.

In particular, there are uncertainties that the People’s Bank of China may be required to take additional steps to depreciate the Renminbi in a scenario of US dollar strength, thereby increasing the risk of a possible one-off currency interference.

Experts believe this scenario could be avoided and expect that the decision makers would manage the Renminbi’s depreciation slowly and transparently.

The decision makers in China are not expected to aggressively depreciate the Renminbi and trigger a currency war to boost the export sector in China.

Instead, the authorities in China would seek to gradually depreciate the Renminbi over a period, as part of decision makers wider strategic goals to further integrate China’s economy & markets into the international financial system.

The inclusion of the Renminbi in the International Monetary Fund’s Special Drawing Right in December 2015 signified a vital step towards the Renminbi assuming a global currency reserve status.

In particular, the Renminbi is projected to be viewed as an alternate currency to the US dollar in Asia, because the market infrastructure within China is developed, generating deeper and extremely liquid local bond & equity markets.

At present, policy initiatives have focused on fiscal stimulus and an easing of credit environments. Therefore, the policy makers appear to be shifting away from currency interventions.

This change of direction from the Chinese authorities seems to be working and the market has witnessed the policy of gradual currency depreciation playing out in 2016.

This trend is expected to continue and the performance of Renminbi would be assessed not only against the US dollar but also against a wider range of other currencies.

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