HONG KONG/SHANGHAI: China's yuan held above recent five-year lows on Thursday as a more cautious U.S. interest rate outlook softened the dollar, but traders expect a gradual pace of currency decline over the rest of the year.
Globally, the dollar was on the defensive after the Federal Reserve lowered its economic growth forecasts and scaled back its rate hike projections on Wednesday, cementing expectations that it will have to skip tightening next month.
On Thursday, the yuan changed hands at 6.5813 per dollar after falling to 6.6047 on Wednesday, its weakest level since January 2011. Against the dollar, the yuan has lost 1.3 percent so far this year.
Since it launched a new-trade weighted yuan exchange rate index in December, China has frequently switched between pegging its currency to the dollar and the trade-weighted basket .
Analysts say this strategy has worked with the basket weakening by nearly 7 percent since its launch. The yuan's move to a five-year low on Wednesday also took place without destabilising wider global markets or inviting sharp criticisms from trade partners.
"Overall, China is testing the yuan's two-way volatility both against the dollar and against a trade-weighted basket," said Huang Yi, head of foreign exchange trading at China Guangfa Bank in Shanghai.
"It appears authorities are serious to reform the mechanism in pricing the yuan's exchange rate by letting the market have a bigger say in the yuan's value, though progress will be gradual."
But with the outlook for the global economy still shaky -- the World Bank cut its global growth forecast to 2.4 percent in 2016 last week -- analysts believe a strategy of actively weakening the yuan without provoking similar action from Asian counterparts will be tricky.
Supporting authorities' confidence in market forces are a recent slowdown in capital outflows and stabilisation in the offshore yuan after Beijing tightened its grip on that market in January.
In its first quarter monetary policy report in May, the People's Bank of China said the country's foreign exchange market has succeeded in achieving a yuan/dollar midpoint mechanism that references both domestic market demand and the yuan's value against a basket of trade-weighted currencies.
UBS estimates recent monthly non-FDI financial outflows have dropped to around $30 billion $40 billion from around $150 billion in December.
Analysts say recent sharp swings in the daily currency midpoint fixing -- such as the record 378 pip weakening on May. 4 -- reflect global currency volatility, chiefly in the dollar, rather than domestic weakness.
And with the Fed becoming more cautious about raising interest rates this year, the greenback may struggle for support while other emerging market central banks may be forced to adopt more dovish policy postures. This would support the yuan's relative strength against other currencies.
Although investors are more pessimistic towards the yuan than any other Asian currency, bearish bets on the renminbi have nearly halved since May 26, according to the latest Reuters poll of 21 fund managers, currency traders and analysts.
"As far as the yuan is concerned, it is becoming a non-story in the foreign exchange markets with most people expecting to be on a slightly weaker trajectory for the rest of the year," an interest rates strategist at a U.S. bank in Singapore said.
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