As China exited the first wave of COVID-19 ahead of other countries, its stronger growth rates, higher interest rates and an export-led recovery saw demand for the RMB rise. Now that those support pillars have eroded, the currency’s recent strength has puzzled investors.
It’s persisted even as the difference between 10-year US Treasuries and Chinese government bonds has narrowed, with Treasury yields rising (making them more attractive to buyers) and Chinese yields falling.
For example, the “yield gap” between the US and China 10-year bonds has fallen from a record high of 2.5% in November 2020 to close to zero recently.
This fueled expectations that the RMB would weaken against the dollar on the basis that the “carry,” or additional yield available in China versus other markets, had disappeared. As China’s bonds would see reduced foreign investor demand, the RMB would see less support. Instead, however, the RMB appreciated against the USD, from CN¥6.6 to CN¥6.35 (Display).
Also puzzling is the fact that, despite being relatively closely correlated to the US dollar trade-weighted index historically, the RMB has sharply diverged from it recently. And the People’s Bank of China (PBOC)—which, in the past, intervened to moderate the RMB’s strength or weakness—has taken no strong action on this occasion.