The Renminbi Outlook: The Journey Is the Reward

Many investors with exposure to the Chinese renminbi (RMB), having enjoyed a strong rally in the second quarter, are worried that policy uncertainties could hurt the currency’s short-term outlook. In our view, however, the risks are balanced in favor of further appreciation.

The recent rally took the RMB to its strongest level in three years against the US dollar and many other currencies. But the euphoria hasn’t lasted. Increasing talk about the Federal Reserve tapering its bond buying program has raised the prospect of higher US interest rates, which could make the dollar more attractive relative to the RMB. The People’s Bank of China (PBOC) has also taken steps to moderate the RMB’s recent rise.

Despite these developments, we believe that the RMB could be poised to make further gains in the short term.

Carry Trade Should Weather Fed Taper

One of the factors underpinning the RMB’s strength has been the attractiveness of its carry trade—that is, borrowing in a lower-yielding currency to invest in the RMB. In this respect, the RMB has benefited from both its relative stability and attractive yield.

The currency has moved broadly in line with the euro and British pound, for example, partly reflecting that they share the same US-dollar denominator. As the Display shows, however, the euro and pound have been more volatile than the RMB over the past decade, resulting in the RMB providing a better risk-adjusted outcome.

Three lines comparing indexed performance of the pound, euro and yuan since 2012. The yuan appears comparatively stable.

When adjusted for carry, or the yield investors earn when buying these currencies, the difference between the RMB and the other currencies is more pronounced (Display).