The Chinese yuan is weakening against the U.S. dollar, with USDCNH rebounding from the lower boundary of its consolidation in response to the return of deflationary pressures in China. The latest CPI reading once again highlights the issue of weak consumer demand in China, which - amid a new trade and technology war with the U.S. - is stimulating production far beyond the absorption capacity of the domestic market.
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Deflation and the Trade War
Consumer prices fell by 0.7% in February, exceeding market expectations of a 0.4% decline (previous: +0.5%). This negative surprise reversed the USDCNH exchange rate by nearly 0.4%, following a period of yuan appreciation driven by the softening (or fading) tariff policy of Donald Trump.
The yuan was primarly supported by mixed macroeconomic data from the U.S., as well as ambitious plans by the Chinese Communist Party to stimulate the technology sector. These factors contributed to capital inflows into Chinese companies, reflected in the gradual gains of the HSCEI index.
However, enthusiasm for Chinese stocks and currency has sharply declined today. The role of the domestic market in driving growth in China has significantly increased following the implementation of 20% U.S. tariffs, while geopolitical uncertainty requires the People’s Bank of China (PBOC) to adopt a more conservative stance to stabilize the yuan amid rising trade barriers.
Additionally, the Chinese central bank may delay further monetary easing to strengthen China's negotiating position against the U.S. and shield the economy from new shocks. This suggests that the burden of demand-side stimulus will likely shift to fiscal policy, which in recent years has been primarily focused on supply-side measures.
Today's yuan sell-off is occurring despite the narrowing gap between U.S. and Chinese 10-year bond yields. The sell-off in Chinese bonds reflects strong long-term growth expectations among investors and an increasing appetite for risk. Source: Bloomberg Finance L.P., XTB Research
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