The yuan started to depreciate against the U.S. dollar in March. Compared to the two short rounds of depreciation in 2021, the new twist to the depreciation this time is that the CFETS RMB Index — which measures the value of the yuan against a basket of 24 currencies including the U.S. dollar and the euro — has fallen about 2.4% since its March high. Historically, when there was a significant drop in the exchange rate against the basket, the depreciation of the yuan against the U.S. dollar was unlikely to end soon.
The immediate trigger for the yuan depreciation was the narrowing of the spread between the short-term Chinese and U.S. government bond yields, as the U.S. began its interest rate hike cycle. Currently, the two-year and five-year Chinese sovereign bond yields are both lower than their U.S. counterparts, and the 10-year Chinese bond yield is essentially on par with the 10-year U.S. Treasury yield. From this perspective, it appears that the yuan’s depreciation has only begun.
