US dollar will stay weak if China has its way: Morgan Stanley

[HONG KONG] As China's currency trades near to its highest level against the greenback since the 2015 devaluation, don't expect the government to engineer a reversal any time soon, according to Morgan Stanley.

That's because Chinese policy makers are now embracing a strong yuan as it helps boost consumption and draw inflows, Hans Redeker, London-based global head of foreign-exchange strategy at the US bank, said Tuesday. Thanks to China's position as the world's largest reserves holder and trade partner, that means the dollar's weakness will persist.

"The rising renminbi has a messaging function into the region if not globally," Mr Redeker said. "It suggests that China sees advantages in a weak US dollar - reverse of renminbi strength - as the weak US dollar helps keep the global economy via credit supported."

China - with its history of intervening in currency markets - has shown a remarkable appetite for a stronger yuan so far. While the nation abruptly devalued the yuan two years ago, currency strength may now be in its favour as it seeks to stem a three-year tide of outflows. With global demand supporting trade, the government may also be less worried about the exchange rate's drag on exports.

A weak US dollar is where Chinese and US interests could overlap, says Morgan Stanley. The US may see dollar weakness as "the quickest and most effective way" to boost competitiveness, strategists led by Mr Redeker wrote in a Feb 2 note.

While a strong yuan risks igniting one-way speculation and dragging down exports, China has embraced it for several reasons, according to Mr Redeker: A weak US dollar eases global liquidity, helping to keep the world economy strong, which allows China to pursue its deleveraging strategy.

When the yuan was falling in 2014, China was pursuing a supply-oriented policy. Now it needs a stronger exchange rate because its strategy is more demand-oriented.

There have been signs China wants to slow the pace of yuan gains, though its efforts have done little so far. On Wednesday, the yuan's fixing was weaker than expected: its distance from the average forecast in a Bloomberg survey the largest since October. In early January, China suspended a component of the fixing mechanism, which was added amid yuan weakness in a bid to reduce volatility.

With a controlled capital account, China can cap fluctuations while allowing a gradual appreciation of its currency, said Mr Redeker. Even as stocks in China and the rest of the world plunged this week, the yuan has extended its climb. It is now the strongest versus a basket of its trade partners' currencies since June 2016.

"It's going to be a renminbi that will be relatively muted, relatively strong, relatively resilient," Mr Redeker said. "When the equity market has been selling a lot, the renminbi is providing FX stability. This supports our view that the US dollar is going to stay weak despite what is happening now."

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