China’s light-speed recovery from the pandemic has reignited the perennial debate about how long the U.S. dollar’s 50-year dominance of global markets can persist.
The U.S.’s struggle to control the coronavirus and revive its economy contrasts sharply with the Asian nation, where growth has roared back. That divergence — which led to the greenback’s worst performance since 2017 as the yuan advanced — has bolstered China’s tilt at dollar hegemony, with investors flocking to onshore assets, trying out the renminbi for trade, and even giving it another look as a reserve currency.
The dollar’s demise as the world’s reserve currency has been idly speculated on and predicted for years, of course. Prior to the yuan, all the hype was about the euro as the dollar’s successor. Nothing, though, ever managed to dent the twin forces underpinning dollar supremacy: the U.S.’s role as both global growth engine and haven of first choice for investors during crises. So powerful were these two pillars that they were given a catchy nickname in trading circles years ago — the “dollar smile.”
But recently, that smile has looked more like a smirk, with the virus eroding both of the currency’s traditional supports. Instead, it’s the yuan that’s benefiting from demand for economic outperformance, and for assets insulated from the pandemic’s fallout, bringing the currency’s long-term prospects back into focus.
“The center of the world’s economy is shifting from the Northern Atlantic, where it’s been for 500 years, to the Pacific,” said Marc Chandler, chief market strategist at Bannockburn Global Forex. “The currency markets are going to reflect that over time.”
It’s a somewhat ironic end to U.S. President Donald Trump’s pursuit of a weaker dollar. Despite frequently admonishing Beijing officials for keeping a lid on their currency to support Chinese exports at the expense of the U.S. — and starting a full-blown trade war to force their hand — it took a pandemic to change the tide.
China is reaping the rewards. The world’s second-largest economy is now set to depose the U.S. as the leading engine of growth in 2028, five years earlier than expected just a year ago after better weathering the pandemic, the Centre for Economics and Business Research said last month.
While American output is poised to rebound in 2021, growing 3.9%, China is on track to expand more than 8%. And its central bank is considering tightening monetary policy — in stark contrast with a pledge from the U.S. Federal Reserve to remain accommodative, which has helped drag down the dollar.
In fact, some see China’s economic success itself — particularly in becoming a linchpin of the global supply chain — reinforcing the trend for low interest rates elsewhere, and increasing the divergence.
“The U.S. and other countries remain reliant on the Chinese supply chain to control the pandemic while vaccinations are rolled out,” said Ben Emons, the managing director of macro strategy at Medley Global Advisors. That advantage is what “keeps G10 central banks highly accommodative.”
Investors have certainly taken notice, pumping $135 billion into Chinese bonds in the 12 months ended Sept. 30, data compiled by Bloomberg show. Equities have also proved popular, luring $155 billion over the same period. While recent New York Stock Exchange confusion around delisting several Chinese companies served as a reminder of the regulatory and trade-related risks surrounding the nation’s assets, investors were largely unfazed.
Ultimately, it’s the record cache of negative-yielding assets elsewhere in the world that has made Chinese debt particularly appealing. China’s 10-year bonds yield more than 3%, versus just over 1% for similar-maturity Treasuries. With these securities also joining a growing number of international benchmarks that help investors set their return objectives, the renminbi is getting another look as a currency for both short- and long-term commitments.
While more than 60% of the world’s currency reserves are denominated in dollars — as they have been for over two decades — holdings of the greenback fell to the lowest since 1996 at the end of the third quarter. The euro, pound and yen have gained from this decline, yet only the yuan has seen allocations increase — to 2.1% — for the last three quarters.
That has some analysts rethinking their approach to the currency. HSBC Holdings PLC sees the yuan increasingly influencing weekly price changes in the pound and commodity-linked currencies, while strategists at Societe Generale SA see it affecting risk sentiment.
The currency is now the fifth-most used currency for global payments, accounting for about 2% of transactions, according to data from the Society for Worldwide Interbank Financial Telecommunications, which handles cross-border payment messages for more than 11,000 financial institutions in 200 countries. While that’s still a small share, when Swift first started tracking currencies in this way in 2010, the renminbi was ranked 35th.
Of course, the investor frenzy for all things China comes with a big caveat: Those flows could push the yuan to strengthen too far, too fast, and precipitate government intervention to stop gains from hurting exports. Officials have historically advocated for a weaker currency to support manufacturers.
Indeed, Citigroup Inc. is predicting the currency could soar to its strongest in almost three decades versus the dollar in 2021. Goldman Sachs Group Inc. forecasts a rise to levels unseen since 2015, and JPMorgan Chase & Co. describes bets on the renminbi as one of its “highest conviction” picks for this year.
It wouldn’t be the first time that officials have acted to stem appreciation. In 2015, Beijing unexpectedly devalued the currency, triggering the yuan’s biggest one-day loss in 20 years. So far, China’s central bank has only moved to slow, rather than halt, the yuan’s advance by making it cheaper for traders to bet against the currency and by relaxing capital curbs to allow more outflows.
But if the currency rises to less desirable levels, policymakers could act more forcibly. They could also delay opening domestic markets further — a prerequisite for the yuan to become a truly global currency.
“Locally, the momentum of FX actions suggest a desire for a slower pace of RMB appreciation,” Nomura strategists including Craig Chan wrote in a December report.
Any intervention would slow not only the yuan’s advance, but also its challenge to the dollar. Despite bullish calls for the yuan from some of the finance industry’s biggest names, the median forecast is for an advance of less than 1% by the currency in 2021. That would lag expected gains of more than 3% for the ruble and over 6% for the Brazilian real, data compiled by Bloomberg show.
Dollar hegemony could also find an ally in former Fed Chair Janet Yellen, who is President-Elect Joe Biden’s pick to helm the Treasury Department. The incoming administration could once again promote a stronger dollar, rebooting a policy that had held since 1995 until fizzling during the Trump presidency.
Still, the uptick in appetite for Chinese assets suggests growing international comfort with the renminbi, and the nation’s economic outperformance is likely to drive further use — even if the greenback remains the dominant currency for trade, capital markets and reserves for some years to come.
“We are extremely bullish on emerging markets, which is fundamentally based on the view the Chinese economy will be strong in 2021 and that China has done a great job dealing with the virus,” said John Malloy, portfolio manager and co-head of the emerging and frontier market team that oversees $10 billion at RWC Partners. “There will be continued pressure on the yuan to strengthen.”
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