Chinese yuan strength may soon wane

LONDON: The Chinese yuan may struggle to maintain the pace of its appreciation against the US dollar and could even give back some of its gains.
The dollar/yuan exchange rate has fallen 1.75 percent since July 25. And on Friday, the appreciating yuan reached its strongest against the dollar since China established the domestic foreign exchange market in 1994.
The scale of the moves may not be huge compared with those seen in other currency pairs but the measured pace encourages traders to take on larger positions. And the bigger the position, the bigger the exposure to any reversal.
While the yuan's gains can be attributed to natural demand before a week-long holiday in China and quarter-end window dressing by the Chinese central bank to spike the arguments of US critics, it is unlikely to be sustainable given the challenges the Chinese economy currently faces.
Some traders already expect the central bank, the People's Bank of China (PBOC), to act to cool demand for the yuan as soon as next week, possibly even by intervening to curb the pace of its appreciation.
The PBOC may have every justification to do so.
China's economy will almost certainly have suffered a seventh straight quarter of slowing growth in the three months to the end of September.
The HSBC China Manufacturing purchasing managers index (PMI) released on Saturday, and Monday's official factory PMI, both stayed below 50, the level which separates expansion from contraction.
Even though both recorded a final index level that was above the August reading, the reports highlighted the problems facing the Chinese economy.
Notably, the HSBC PMI's export orders sub-index slid to a three-and-a-half-year low of 44.9.
With exports generating 31 percent of China's gross domestic product in 2011, according to World Bank data, that slide is not good news. And the yuan's strength is not going to help.
Other data also suggest the Chinese economy is losing momentum.
A further slowing in Chinese growth for the ninth consecutive quarter was already flagged in the Chinese media by a government think tank on Wednesday.
Chinese factory output languished at 39-month lows in August while industrial profits fell 6.2 percent in the same month, compared to a year earlier.
Baoshan Iron & Steel Co., China's biggest listed steelmaker, has already suspended output at a 3 million ton-a-year plant in Shanghai as steel prices approach three-year lows.
About 40 percent of Chinese iron ore mines have halted their operations.
Against this economic background, the Chinese yuan's strength against the US dollar may seen unsustainable.
An October rebound in the dollar, say to the 200-day moving average, which is currently at 6.3302 yuan, would leave China's currency looking more appropriately valued and catch yuan longs unawares.
— Neal Kimberley is an FX market analyst for Reuters. The opinions expressed are his own.