Will China Repeg to the U.S. Dollar?

Caixin: Reasons Not To Be Alarmed By A Tumbling Yuan
This puts the central bank in a tough spot. It has promised to adhere to the new rules of calculating the yuan's central parity rate, which link it to the currency's closing price on the previous day in the onshore foreign exchange market. Judging by recent data, it has indeed kept the promise. But keeping the promise also means it will have to allow the yuan to continue to devaluate against the U.S. dollar, because that's what the supply and demand conditions in the market indicate will happen.

In a sense, the central bank has made an unwilling choice to let the yuan face increasing devaluation pressures, because it wants to keep the new rules for central parity rate. But there is a risk that it may one day lose control of the situation. So how far is the government willing to push the limit, before it may have to backtrack on the new rules?

That's a question to which all investors would like to know the answer.
The key to this entire question rests on the U.S. dollar.
In my view, there is no need to worry too much about the yuan's exchange rate for the rest of the year. The reasons are two-folded.

First, the U.S. Dollar Index has limited room for growing further this year.
They authors argue the U.S. economy is relatively weak and interest rates are low and not likely to rise. However, while they note Europe and Japan are doing QE, they do not look at the relative changes in interest rates. If Japan and Europe are cutting interest rates, it has some effects similar to a Fed rate hike. The current divergence need not end any time soon: The Fed and the ECB: “Spurious Bedfellows”
Even if it does end, the result will be inflows into the U.S. bond market and a likely rise in the U.S. dollar which will make for a supercharged bull market in bonds.

Let's say that happens, what could the PBoC do?
Second, the Chinese central bank wants to keep the yuan's exchange rate stable and has the ability to do so. If necessary, it may temporarily put the new rules aside and peg the yuan more to the U.S. dollar than a basket of currencies.
If economic conditions were stable, I could see the PBoC driving up the yuan exchange rate to take heat off the U.S. dollar and stabilize the global markets. What are going to be the conditions if the U.S. Dollar Index has broken 100 and is on its way higher? The PBoC runs the risk of being broken by a peg as capital flows out of China amid a strong U.S. dollar bull market. We are already at this point because of the U.S. dollar rally and the prior peg.

The yuan is a derivative of the U.S. dollar, more so than many other fiat currencies. The PBoC can choose how it reacts to the U.S. dollar, but it cannot control the U.S. dollar. If the dollar rises again, the PBoC can choose deflation or currency depreciation.
Taken together, if the U.S. dollar continues to strengthen significantly, it is possible that the Chinese central bank may backtrack on the progress it made on the yuan's exchange rate system, so the central parity rate will depend more on the value of the U.S. dollar than that of a basket of currencies. But this will be temporary, and when conditions allow, it will switch back to emphasizing a basket of currencies over the U.S. dollar.
That is a strategy for running up the value of the yuan, pegging to USD in a dollar bull market, and depegging in a bear market. If the PBoC repegs amid a dollar rally, it will have to stay pegged through at least part of the USD bear market or risk sharp depreciation when it depegs. If history rhymes at all, it would mean a repegged yuan in 2016 or 2017 may not depeg until sometime in the early 2020s.

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