Goldman Sachs sours on outlook for Chinese yuan

Analysts at Goldman Sachs soured on their outlook for the Chinese currency, telling clients that successively weaker fixings for the yuan´s value against the dollar "could easily reignite capital flight" from Asia´s largest economy.

Furthermore, the 'knock-on' effects that could have on America´s S&P 500 equity benchmark might "potentially" prevent the US central bank from tightening monetary policy "too quickly", analysts Robin Brooks, Silvia Ardagna and Michael Cahill said in a research note sent to clients and dated 2 June.

"One regularity over the past year has been that the S&P 500 has fallen sharply within a week or two of $/CNY fixing meaningfully higher, as focus on capital outflows and RMB depreciation has built," they said.

The exact mechanism behind their prediction was the fact that domestically, in China, the only 'signal' that mattered was the Chinese currency´s exchange rate against the US greenback.

That meant that Chinese officials´ management of their currency had a 'weak link', despite what Goldman described as a "clearly communicated " shift in focus by officials towards the trade-weighted value of the currency.

Beijing´s expectation was that depreciation in the yuan´s exchange rate against the US dollar, if accompanied by strength versus the currencies of its other main trading partners, would result in a largely stable trade-weighted exchange rate.

Economic agents´ expectations for the future path of the yuan were the key driver of capital flows, Goldman said.

"That said, our base case remains that the US economy is strong enough to withstand a tightening cycle that will take the Fed funds target to 3.4 percent in Q3 2019," Brooks, Ardagna and Cahill wrote in the same research report.

Nonetheless, Goldman´s warning was made before the release of the much weaker-than-expected US jobs report for May, on 3 June, which at least initially appeared to dampen expectations for Fed tightening.

Likewise, the analysts poured cold water on any speculation that the People´s Bank of China might not have sufficient international reserves in order to maintain the yuan´s stability, despite which speculation of a one-off devaluation was likely to rise.

"We remain in the camp that the level of China’s reserves (currently around $3,200bn) is more than sufficient to deal with this pace of drawdown, but – realistically speaking – we see a good chance that markets will again speculate over the need for a one-offdevaluation, even if the message from policy makers has been that this is not on the cards."