We all know that while the rest of the world is a bit of a funk, the US is currently the beacon of light on the horizon that keeps nay-sayers at bay with better-than-expected data for the past year. The baton of economic growth has been passed down from China to the US since countries opened up after COVID. The question is, how bad are things in China and what does this mean for China, the Yuan and the markets in general?

The first clue that everything is not going well in China is by looking at what the Central Banks are doing in the country versus the rest of the world. While the rest of the world is in various stages of hiking interest rates or keeping rates on hold and higher for longer, we have seen the People’s Bank Of China cutting several interest rates in an attempt to start the Chinese economy going again.

One of the primary causes behind the downturn in the Chinese economy can be attributed to the collapse of the real estate market in China. To put it mildly, the housing market is in a slump, and this is having a severe impact on an economy where rising property prices used to be a major driver of wealth. We’ve witnessed the collapse of several property developers in China, with Country Garden Holdings struggling to make bond interest payments.

China Property Sector under water


What implications does this have for the Chinese Yuan? The primary responsibility of the People’s Bank of China (PBOC) is to ensure the stability of the currency and foster economic growth. Currently, the PBOC is adjusting interest rates, but this strategy predominantly benefits one aspect of the economic equation, and it does not favour the Chinese Yuan. As previously mentioned, while the US is increasing its interest rates, China is reducing them, resulting in the widest disparity in 10-year government bond yields between the two countries in over a decade. Given that investors are seeking opportunities in nations where they can attain the highest returns on their investments, it doesn’t seem rational to allocate capital to China under these circumstances.

While we have seen the Chinese Yuan weakening, we have not seen a widespread weakening that is warranted and that is due to the PBOC setting the daily reference rate at levels that defy market expectations. With them setting the rate above market expectations it gives the market a gauge as to the extent to which the PBOC influences the yuan. The one thing the PBOC has not done is intervene with a massive stimulus package which leads one to believe that the currency will have to bear some of the burden.

Chinese Yuan slowly trending weaker


Another consequence of a depreciating Yuan is the broader impact it will have, exerting additional pressure on an already strained property market, the Chinese stock market, and trade relationships with major trading partners. A weaker Yuan is likely to trigger similar reactions in regional currencies as global confidence in China wanes.

In the latest set of Chinese economic indicators, there has been an increase in retail sales and GDP data. However, for the market to truly believe in a turnaround in the Chinese economy and for confidence to be restored in the country, this positive trend needs to be sustained. It appears that the PBOC may have relaxed its commitment to defending the Yuan at any cost, potentially leading to further depreciation, especially in the face of a strong US dollar.