The Yuan's Rough Ride May Continue in 2015

01/05/2015 9:00 am EST

Focus: FOREX

The staff at Forex.com examines the difficulty China had to endure in 2014 as well as the pressure this had on the yuan versus the US dollar and they offer insight as to what a currency trader should be on the lookout for in 2015.

2014 was a rough year for the yuan as it ended the year lower against the US dollar for the first time since 2009. The performance of USD/CNY mirrored diverging economic outlooks for the US and China. While the US economy continues to recover from the global financial crisis, China is attempting to combat soft levels of domestic and global demand by increasing stimulus. Against this fundamental backdrop it's not hard to see why USD/CNY is heading higher.

At a time when the market was preparing for tighter monetary policy in the US, the PBoC was cutting interests rates and using other policy tools in an attempt to support economic growth. There are two main sources for growth in a modern economy: domestic demand and global demand. China has historically been an export based economy, but it is attempting to transition towards a more effective growth model that takes advantage of China's massive population. As urbanization continues to transform China into a more developed economy, it can tap into a more reliable and sustainable growth conduits stemming from within its own economy.

However, recent economic indicators show that domestic demand in China isn't as strong as Beijing would like. Consumer price growth remains trapped below 2.0% (it's expected to have increased 1.4% y/y last month) and producer prices remain in deflationary territory. Retail sales, manufacturing, import and industrial production figures also broadly deteriorated in 2014. This is limiting a key conduit for growth in China.

At present exports are doing most of the leg work. China's export market performed fairly well for most of last year. Some data from earlier in the year was distorted by fake invoicing in early 2013, but the general trend of strong export growth is encouraging. The final figures for 2014 are due out on the 12th and are expected to show that exports grew a solid 6.0% in the year to December.

Nonetheless, growth figures, which are due out later this month, are expected to show that GDP growth softened to 7.4% last year, after increasing 7.7% in the prior year. This year, GDP growth may weaken ever further (current estimates around 7.0%). To even reach 7.0% some analysts are saying that even more stimulus may be needed, possibly in the form of an interest rate cute and a RRR cut. The PBoC has enough room to do this given the diminishing threat emanating from China's property market. Falling property prices are still a concern, but data released towards the end of last year showed that downward price pressure is easing.

The need to make monetary policy more accommodative in China may keep USD/CNY afloat in 2015. When the Fed begins hiking interest rates will be another major theme for the pair, especially if the Fed begins tightening sooner or later than currently expected. In China, the idea of the yuan as a one-way beat was clearly dispelled in 2014, thus the market may be more comfortable with CNY weakness than it was only a couple of years ago. Also, the PBoC may also be more comfortable with a weaker yuan, as it would provide much needed support for China's all-important export sector. We are keeping an eye on 2014's high just above 6.26.

By the Staff at Forex.com

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