MNI INTERVIEW: Further Yuan H2 Appreciation Uncertain – Guan

Sustained yuan appreciation in the second half remains highly uncertain, a prominent Chinese economist told MNI, warning the Federal Reserve's hawkish stance and renewed tensions in the Gulf are likely to cap further gains.

Guan Tao, global chief economist at BOC International, said in an interview that the yuan's recent performance resembled its trajectory in 2021. The currency appreciated 9.3% against the U.S. dollar between June and December 2020 before stalling around 6.37 the following year, then entered a prolonged period of depreciation as stronger-than-expected U.S. growth and rising inflation fuelled expectations of Fed tightening, while the China-U.S. yield differential narrowed and the dollar strengthened.

In the first half of this year, the U.S. dollar index rose 3%, while the yuan central parity strengthened 3.2% against the greenback and the onshore yuan appreciated 3%, outperforming the offshore yuan's 2.7% gain. The CFETS RMB Index, which measures the yuan against a basket of major currencies, also rose 4.7% to 102.59, its highest level since August 2022. (See MNI INTERVIEW2: Yuan To Rise Against Euro Amid Forex Tensions)

TWO-WAY VOLATILITY

Guan expects two-way volatility to intensify in the second half as domestic and external uncertainties increase. In the near term, AI-related industries should continue supporting China's economy and capital markets, China-U.S. trade relations are likely to remain broadly stable and the trade surplus should stay large, all of which are supportive for the yuan.

However, significant headwinds remain. The Fed's hawkish stance could widen the China-U.S. interest-rate differential further after spreads between U.S. and Chinese two- and 10-year government bond yields widened by 74 basis points and 44bp in the first half. Foreign investors have continued reducing holdings of yuan-denominated bonds since the second quarter of 2025. The renewed Iran conflict has also boosted dollar demand, weighing on non-dollar currencies. The greenback could strengthen further in H2, while the possibility of additional U.S. tariffs on other countries remains another important source of uncertainty for the yuan, Guan said.

Although AI-driven industries are emerging as new growth engines, they have yet to offset weakness in traditional sectors. China's economy remains in a difficult transition, while foreign investor confidence in Chinese assets needs to be further promoted. Balance of payments data show average quarterly net foreign capital inflows of just USD5.2 billion between Q2 2025 and Q1 2026, well below the USD158.5 billion average recorded between Q3 2020 and Q1 2022 during the previous period of yuan appreciation, he noted.

Guan also warned that a stronger yuan would generate exchange losses on both China's trade and financial accounts, creating a macroeconomic tightening effect the country has never experienced, as the private sector shifted to a USD254.9 billion net external asset position at the end of Q1 from net external liabilities of USD1.21 trillion at the end of 2021, while the country's trade surplus continued to expand.

Given the market's sensitivity to further yuan appreciation, authorities should strengthen monitoring of capital flows, stabilise expectations and guard against exchange-rate overshooting, Guan said.

UNRELIABLE PPP GUIDE

One argument supporting further yuan appreciation is that the currency remains undervalued on a purchasing power parity (PPP) basis. (See MNI INTERVIEW: Yuan In Steady Upward Trend - Sheng Songcheng)

But Guan questioned the usefulness of PPP as a guide to short-term exchange-rate movements. The Japanese yen, for example, has been more than 30% undervalued relative to PPP since 2023, yet it has continued to weaken to near four-decade lows despite the Bank of Japan's rate-hiking cycle.

More broadly, market exchange rates do not necessarily converge toward PPP. Asian currencies including the Singapore dollar, South Korean won and New Taiwan dollar have remained persistently undervalued relative to PPP over the past three decades, with estimated undervaluation still ranging between 40% and 60% last year, Guan said.