(Yicai Global) Feb. 20 -- Yicai Research Institute, a non-profit independent think tank backed by China’s largest financial media group Yicai Media Group, has released the Chinese yuan exchange rates report for 2022, which reviews the performance of the yuan’s exchange rates last year and makes predictions for this year’s US dollar index and yuan exchange rates.

Review 2022

The progress of China’s Covid-19 prevention and control policies was one of the main factors influencing China’s economic fundamentals and the yuan exchange rates. The US Federal Reserve’s interest rate hikes and the Russia-Ukraine conflict also had a profound impact. 

From late March to the end of May, several omicron outbreaks erupted in many Chinese cities, including Shanghai, leading to lockdown and shutdown measures, thus affecting China’s economic fundamentals.

As a result, the Chinese yuan began to depreciate against the US dollar, sinking 6.1 percent to 6.77 on May 19 from 6.38 on April 19. The broader yuan exchange rate against a basket of currencies calculated by the Yicai Research Institute fell 3.2 percent to 99.13 at the end of May from 102.37 in early April.

Shanghai lifted lockdown and shutdown measures between June and July, releasing demand and production that were previously stalled and leading to a brief rebound in economic indicators. In this period, the Chinese yuan exchange against the greenback remained mostly stable around 6.7, while the Yicai Research Institute’s broader Chinese yuan exchange rate rose 3.9 percent to 102.95 in mid-July from 99.13 at the end of May.

Between August and November, more omicron outbreaks appeared in the country, commercial housing projects in several Chinese cities faced delay risks, and export growth slowed down. Therefore, the redback exchange rate against the US dollar softened to above 7.3. The broad yuan exchange rate calculated by the Yicai Research Institute also fell 4.9 percent to 96.11 on Nov. 30 from 101.02 on Oct. 14.

China eased its epidemic prevention and control policies in December. Since then, citizens no longer need to show their health codes to enter public places.

Economic activities slowed down since December for a short period because of the soaring number of Covid-19 cases, leading to the worsening of multiple economic indicators from November.

However, between Dec. 1 and Dec. 31, the Chinese yuan appreciated against the US dollar to 6.95 from 7.08. The Yicai Research Institute’s yuan exchange rate also rose to 96.55 from 96.11 in the period. Why? Because the ease of epidemic prevention and control policies led to a shift of market expectation to a better economic outlook..

After the infection peak, the Covid-19 impact on residents, companies, consumption, and investments began to fade away. The traffic congestion index of 35 major Chinese cities jumped to the highest level since November, high-frequency traffic data showed.

The US Federal Reserve’s monetary policy also had a deep impact on Chinese yuan exchange rates. Last year, the US dollar index jumped 7.6 percent to 103.5 from 96.2 due to the tightening cycle of US monetary policy, and the Chinese yuan depreciated 8.3 percent to 6.95 from 6.37 against the US dollar. The two figures are closely related to each other.

During the period of late October and November, the US dollar index began to fall, but the USD/CNY exchange rate continued to rise. There were two possible explanations behind this phenomenon.

First, after US dollar index climbed above the threshold of 110 in late September, the market sentiment about yuan depreciation became so strong that the investors continued to convert their yuan into US dollars, pushing up dollar demand.

Second, in November, Covid-19 infections were rising in China and multiple city governments turned to more strict measures in epidemic control, the market expectation about China’s economic fundamentals became more pessimistic and Chinese yuan once depreciated over 7.3 against US dollar.

Outlook 2023

China’s economy is expected to improve this year, as the government rolls out a slew of policies to revive the housing market, boost consumption and spur investment in infrastructure construction. Domestic demand is also expected to pick up now that the country has relaxed its pandemic prevention measures.

Yet the growth prospects of overseas economies in 2023 remain highly uncertain, with the biggest risks still being the direction of the US economy and potential rate hikes by the Federal Reserve. The global economy has shown a high degree of synergy since 2008. If the US falls into a recession, it will have a negative impact on the global economy, which will further affect China’s foreign trade environment.

Based on these circumstances, the Yicai Research Institute has made two predictions regarding the yuan exchange rate this year. One is that the US dollar will weaken and the other is that the yuan exchange rate is likely to rally and China’s foreign trade will become the key factor.

Inflation and economic fundamentals in the US are key factors that determine the Federal Reserve’s monetary policies and the trend of the greenback.

Market players generally predict US economic recessions through an inverted yield curve of US treasuries, when short-term interest rates surpass that of long-term ones, indicating that the market lacks confidence in the future economic situation.

The inverted yield curve has widened in the US since July last year, with an average spread of 44.5 basis points between long-term and short-term interest rates, and the largest spread was 84 bps. The current spread and duration are larger and longer than those during the financial crisis in 2008 and the Covid-19 pandemic in 2020, according to recorded data.

In the early 1980s, the Federal Reserve adopted an aggressive interest rate hike policy to fight hyperinflation, when the interest rate spread of US treasuries reached as much as 200 bps or more. The US economy entered a recession in 1981 and 1982, with the unemployment rate hitting over 10 percent in 1982.

The current situation in the US is similar to the 1980s. Whether the US will eventually enter a recession as expected by market participants, the Federal Reserve’s current interest rate hike policy and the slowdown in economic indicators signal that the fundamentals of the US economy will weaken in 2023, which will also be the most critical factor in the softening of the US dollar index.

As for China’s foreign trade, overseas demand this year is likely to be weaker than 2021. Economic growth in developed economies may contract further in 2023 compared to 2022, which will drag down China’s foreign trade performance, according to the forecast by the International Monetary Fund.

The Chinese economy has experienced a downturn during the years when foreign trade was weak, according to economic performance data since 2009. Although net exports account for only 3 percent of China’s gross domestic product, foreign trade has a great impact on the country’s economy, as it relates to a range of upstream and downstream manufacturing industries and the retail sector, and has a broad impact on employment and consumption.

In addition, foreign trade performance is also related to the yuan exchange rate. For example, in 2021, China’s exports grew strongly, surging more than 20 percent year on year most months. The redback’s exchange rate strengthened together with the US dollar in 2021.

Therefore, stable foreign trade is an essential precondition for the yuan exchange rate to rally in 2023. Conditions for foreign trade in China are much better now than in 2022 after the country eased its Covid-19 prevention policies. Market players expect corporate orders to begin to bounce back.

Editor: Futura Costaglione, Kim Taylor, Dou Shicong