As the Federal Reserve considers cutting interest rates, a significant shift in currency markets could ensue, potentially leading Chinese companies to repatriate up to $1 trillion in dollar-denominated assets, according to Stephen Jen, CEO of Eurizon SLJ Capital. This massive flow of capital could drive the yuan’s value up by as much as 10%, Jen suggests.
Jen, known for his insights into currency dynamics, argues that currency risk is currently underappreciated in financial markets, with the yuan poised to play a pivotal role. “Think of it as an avalanche,” Jen commented, referring to the potential impact of these repatriation flows. He predicts that the yuan could appreciate by 5% to 10% in response to these movements, a range that he believes would be manageable for Chinese authorities.
Since the pandemic, Chinese firms have accumulated more than $2 trillion in offshore assets, benefitting from higher returns compared to yuan-denominated investments. However, as the Federal Reserve lowers interest rates, the attractiveness of dollar-denominated assets diminishes. This could lead to a significant portion of these investments—estimated at around $1 trillion—flowing back into China as the interest rate differential between China and the US narrows.
Jen, a prominent proponent of the “dollar smile” theory, expects the Fed to implement rate cuts more aggressively than currently anticipated if US inflation continues to decline. This, combined with the US dollar’s overvaluation, America’s twin deficits, and the potential for a soft landing in the US economy, supports his view that the dollar will weaken. This weakening could further bolster the yuan.
As of Monday, the yuan was trading at approximately 7.12 per dollar in the onshore market, a notable recovery from its July lows of nearly 7.28. The yuan’s rally could be more pronounced if the People’s Bank of China does not intervene to absorb excess dollar liquidity, Jen noted in a recent interview.
The possibility of Fed rate cuts was highlighted by Fed Chair Jerome Powell’s recent remarks at the Jackson Hole symposium, signaling that the time may be ripe for policy adjustments. However, Jen believes that a significant impact on the yuan will likely occur not immediately but as the dollar’s decline accelerates, potentially in a scenario where US inflation eases without triggering a recession.
Guan Tao, a noted economist at Bank of China International Ltd., shares a similar outlook, warning that the yuan could experience a substantial increase if conditions mirror the collapse of the yen carry trade.
I am Aparna Sahu
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