Yuan can extend 3% gain as exporter flows drive strength, BofA says

The offshore yuan traded near 6.77 per dollar Thursday after outperforming most regional peers in the first half, and Bank of America Corp. sees further gains ahead as exporter dollar sales create a self-reinforcing cycle of strength.

"Strong overseas demand for Chinese exports has generated a steady supply of dollars flowing into the domestic market, while companies have shown a greater willingness to convert those earnings into yuan," strategists at Bank of America said in a note dated Thursday.

The yuan has appreciated more than 3% against the greenback this year even as trade tensions and weaker terms of trade weighed on the outlook. Portfolio investment flows have had limited impact on the currency due to low foreign ownership of Chinese assets and managed capital outflows, the bank said. Instead, exporter-related currency flows have become the dominant driver of USD/CNY direction.

The positive feedback loop — where expectations of yuan appreciation encourage more exporter dollar sales, which in turn strengthen the currency — is likely to persist unless the dollar stages a much broader rally, BofA said. A move in the Bloomberg Dollar Spot Index into the 102-105 range, potentially supported by higher Federal Reserve interest rates, would be needed to materially challenge the yuan's momentum.

The yuan's strength contrasts with weakness across much of Asia. The Japanese yen has fallen more than 10% this year, while the Korean won and Thai baht have also declined, making the yuan an outlier in the region's currency landscape.

Bank of America's view aligns with Goldman Sachs Group Inc., which forecast in May that USD/CNY would fall to 6.50 over the next 12 months, implying further gains of about 4% from current levels. Both banks cite China's strong export performance and sustained current account surplus as a structural tailwind for the currency that outweighs near-term headwinds from trade policy uncertainty.

For global investors, a stronger yuan has implications beyond the currency market. It reduces the cost of Chinese imports for the rest of the world, potentially easing inflationary pressures in countries that source goods from China. At the same time, it pressures multinational corporations with China exposure, as their dollar-denominated earnings from the country shrink when translated back into dollars.

Dollar Strength Remains the Key Risk

The main threat to the yuan's rally would be a broad-based dollar advance. Bank of America said the dollar index would need to climb into the 102-105 range — roughly 3% to 5% above current levels — to meaningfully disrupt the yuan's momentum. Such a move would likely require the Federal Reserve to maintain higher interest rates for longer than markets currently price, diverging from the People's Bank of China's easing cycle.

Overnight index swaps currently price about 50 basis points of Fed rate cuts over the next 12 months, suggesting markets expect the US central bank to ease policy. If those expectations are pared back, the dollar could strengthen, testing the yuan's resilience.

The People's Bank of China has largely allowed the yuan to trade in line with market forces, setting its daily fixing — the midpoint from which the onshore yuan can trade 2% in either direction — at levels that reflect the currency's strength. The fixing has been set consistently stronger than market expectations in recent weeks, signaling the central bank's comfort with the yuan's appreciation.

This article is for informational purposes only and does not constitute investment advice.