Why the Chinese yuan is likely to strengthen in the coming years

Editor's note: Chen Jiahe is the chief investment officer at Novem Arcae Technologies. The article reflects the author's opinions and not necessarily the views of CGTN.

In today's world economy, the exchange rate between the Chinese yuan, or renminbi, and the U.S. dollar is one of the most important foreign exchange rate pairings, as it represents the currency relationship between the world's two largest economies.

Looking into the past, the yuan's exchange rate for every U.S. dollar (USD-CNY) has been rising for two years running. 

According to data provided by Choice Financial Terminal, the USD-CNY rate was at 6.3550 at the end of 2021. In 2022, it rose by 8.33 percent. And in 2023, up to December 4, it increased by another 3.16 percent and now, as this is being written, stands at 7.1338.

Over the past two years, the USD-CNY rate has increased by a significant amount of 12.25 percent. For an exporter in China, a 12.25-percent increase in the currency means income will increase by the same amount, and profit will rise even more dramatically. This is under the assumption that the export volume remains the same. However, this assumption may fail, since the rising price of export products will lead to reduced purchasing volume.

On the other end, for the U.S. economy, a sharply rising dollar against the yuan is not favorable as well. The positive impact is that this will increase the purchasing power of U.S. consumers, thus helping the Federal Reserve with its long-drawn battle against high inflation, accumulated during the COVID-19 pandemic era. However, for U.S. producers and exporters that provide millions of jobs to U.S. workers, a currency exchange rate that rises by 12.25 percent in less than two years' time is a tragedy, meaning that the cost of their products will be much higher in the global market, thus undermining the competitiveness of their products.

Now, there is some good news for U.S. exporters, as well as those investors who are thinking about "bottom fishing" in the Chinese market. (Note: Bottom fishing refers to investing in assets that are considered undervalued, in hopes of a rebound.) There is a large chance that the USD-CNY exchange rate will decrease in the coming years. That means that a depreciating U.S. dollar will boost local companies with an irreplaceable effect, and an appreciating yuan can make Chinese assets more attractive to global investors.

Here are some reasons that support this trend:

The gradually recovering Chinese economy is a strong force behind the appreciation of the yuan. The Chinese economy has been gradually recovering in 2023. Although the sluggish real estate market has placed a heavy strain on related industries, such as construction, furniture and home appliances, the industries that have less connection with the real estate market have been recovering strongly, such as daily consumption, tourism, filming and so on. As impact from the real estate market seems to have decreased in recent months, a further recovery of the Chinese economy in the coming 2024 can be expected. And this will unleash a very positive influence on the value of the yuan.

Next, the inflation in the U.S. economy is now finally coming under control as the consumer price index (CPI) in October is reported at only 3.2 percent and is believed to be heading toward the 2 percent target. The pressure for the Fed to raise its interest rate is now largely alleviated. There is even market expectation for a reduction of the benchmark interest rate. Should this happen, market demand for the dollar will reduce, leading to a depreciation in the currency, thus increasing the competitive strength of U.S. products in the global market. This obviously will also create more jobs in the U.S. manufacturing industry.

In fact, historical data on the USD-CNY exchange rate tells us that the threshold of 6.7000 seems like a very important number for determining the relationship between these two currencies. An exchange rate above 6.7000 entails a depreciation in the dollar against yuan and an exchange rate below this level means the opposite. As a result, a few years of appreciation in the U.S. dollar against the yuan usually leads to a few years of depreciation, and vice versa.

Between 2010 and 2013, the U.S. dollar depreciated for four straight years and the USD-CNY rate finally reached 6.0539. Then there came three years of appreciation in the dollar and in the end of 2016, the exchange rate stood at 6.9467. This was followed by one year of depreciation in the dollar in 2017, and two years of appreciation between 2018 and 2019, where the exchange rate fluctuated around the level of 6.7000. After that, the exchange rate, which depreciated for two years in 2020 and 2021, appreciated again. Over all, the USD-CNY exchange rate has fluctuated around 6.7000 like a pendulum clock.

Now, the USD-CNY exchange rate is once again at 7.1333, which is 0.4333 higher than the threshold of 6.7000. As the Chinese economy further recovers and the Fed moves to rate cuts, there is now a rising possibility that we will witness an appreciating yuan in the coming years. Taking this under consideration, global investors should start to pay more attention to Chinese assets.