Commentary: The Yuan Forges Its Own Path

Summary:

The Chinese yuan has appreciated 2.8% against the U.S. dollar so far this year, defying the common assumption that its gains are purely the result of a weakening dollar. In fact, since July, despite a 2% rebound in the dollar index, the yuan’s nominal effective exchange rate—the rate against a trade-weighted basket of currencies—has climbed 2.2%. This indicates that the yuan has entered what analysts call an “independent rally.” Over this period, the yuan has strengthened not just against the U.S. dollar but also against other Asian currencies, including notable gains of nearly 12% against the Japanese yen. This movement marks the second phase of the yuan’s recovery from undervaluation to a more reasonable range.[para. 1][para. 2][para. 3]

Previously, market consensus anticipated significant appreciation across Asian currencies, but since July, the yuan has diverged by appreciating versus its peers, such as the yen, South Korean won, Singapore dollar, and New Taiwan dollar. The trend accelerated after Japan’s new prime minister, Sanae Takaichi—an advocate of loose monetary and fiscal policies—was elected, which led to stronger yen depreciation and boosted the yuan’s rise.[para. 3][para. 5]

Several recent catalysts have contributed to the yuan’s appreciation. Surprisingly, increased U.S.-China trade friction this year, especially concerning new tariffs, did not weaken the yuan but strengthened it. Positive drivers include narrowing interest rate differentials as the gap shrinks between U.S. and Chinese rates, robust Chinese exports, greater demand for yuan settlements, and expectations for further yen depreciation. In particular, after Donald Trump’s threat of 100% tariffs was followed by renewed U.S.-China negotiations, markets perceived a de-escalation of trade tensions, which further buoyed sentiment around the yuan.[para. 6][para. 7][para. 8]

If the U.S. moves toward reducing the recently imposed “fentanyl” tariff (which caused earlier yuan depreciation), it could trigger another push for yuan appreciation.[para. 9] Changes in interest rate policy have also played a role. The People’s Bank of China cut its policy rate minimally, while the U.S. Federal Reserve has begun a cycle of rate cuts, narrowing the typical advantage of holding dollars. The 10-year China–U.S. bond yield gap shrank from around -3 percentage points to -2.1 points since the start of the year.[para. 10][para. 11][para. 12]

China’s export strength further supports the yuan. Exports grew by 6.1% year-on-year in the first nine months, outpacing last year and driving the trade surplus up 26%. Competitive factors include strong supply chains, low costs, and efficient services, all magnified by the yuan’s earlier depreciation against the trade-weighted basket.[para. 13][para. 14] Depreciation expectations have faded, with foreign exchange settlements at record highs since March 2021, and capital inflows improving. This positive sentiment is reinforced by stable domestic capital markets and net inflows into securities.[para. 15][para. 16]

The article argues that the foundations for medium- to long-term appreciation remain robust. The dollar’s perceived overvaluation (by 10–15%), weakening structural support, and U.S. moves toward fiscal expansion and “de-globalization” are reducing demand for the dollar. In contrast, the yuan’s real exchange rate has adjusted by 17.9% since April 2022, supporting its competitiveness.[para. 17][para. 18][para. 19]

Over-allocation to the dollar by Asian exporters and central banks is likely to reverse as global “de-dollarization” proceeds, with the potential for up to $800 billion in Chinese export earnings that could be repatriated. An appreciating yuan should also drive revaluation of yuan-denominated assets, especially Hong Kong stocks, as both exchange rate and asset values reflect improving expectations and attract foreign capital inflows.[para. 20][para. 21][para. 22][para. 23]