CNY: Asymmetries Everywhere

China’s currency has strengthened to a multi-year high on a trade-weighted basis, boosted by record trade surpluses along with an appreciating US dollar. But there are now fundamental and unprecedented asymmetries in the outlook for the yuan, all of which suggest limited prospects for further appreciation and a higher probability of depreciation in 2022 than last year. These unbalanced risks include the following:

• Inflows are much more likely to weaken, rather than strengthen. China’s trade surplus reached an all-time high in 2021 and exports should slow this year, while portfolio inflows should also decline due to narrowing US-China yield spreads.
• Outflows are far more likely to strengthen, rather than weaken. China’s COVID controls on travel have played a key role, but even without lifting them this year, declining growth prospects and lower Chinese interest rates should accelerate outflows.
• The PBOC is far more likely to resist further currency strength rather than sudden currency weakness. As the currency has surged, the PBOC is openly declaring larger purchases of FX reserves, and declaring their intention to resist “one-way” currency moves, reducing the prospects for significant appreciation.

Despite these asymmetries, international payments should still be imbalanced in 2022, with more inflows than outflows. One of the key uncertainties in the currency outlook remains when these future expectations start influencing cross-border flows in the present. Also critical will be any signals regarding the timing of lifting China’s “zero COVID” policies or international travel restrictions, which could kickstart additional outflows.