Macquarie Group said that if Chinese mainland companies sell large amounts of their dollar holdings, triggering a sharp reversal in capital flows, the RMB/USD exchange rate could rise to 5 yuan per U.S. dollar.
Economists pointed out in a report that as long as domestic demand remains weak and exports stay resilient, the appreciation of the yuan may reflect the overall weakening of the U.S. dollar rather than a strengthening of China’s economic fundamentals. However, they also noted that if exports weaken and Beijing increases stimulus measures, unwinding of yuan carry trades could trigger a sharp rise in the yuan, with the exchange rate potentially reaching 6 or even 5.
Macquarie estimates that Chinese companies have accumulated approximately $800 billion in U.S. dollar positions, primarily through arbitrage transactions. Arbitrage involves investors borrowing low-yielding currencies and reinvesting them into higher-yielding assets. If these transactions reverse, the renminbi could shift from being a currency mainly driven by U.S. dollar fluctuations to one primarily supported by domestic factors, which would impact China’s economy and financial assets.
This appeal comes as Chinese companies have been accelerating their foreign exchange transactions since the end of last year, with the yuan’s depreciation against the U.S. dollar surpassing the 7-yuan mark faster than expected. Despite overall strength in the dollar driven by tensions in the Middle East, the yuan has outperformed other Asian currencies over the past three months.
Economists wrote: “If China’s strong stimulus measures boost domestic demand, and as business confidence improves and the yield gap between China and the U.S. narrows, RMB carry trades will begin to unwind, leading to a greater appreciation of the yuan against the dollar.”
