Morgan Stanley Warns of Slowing Yuan Rally, Contrasting with Market Expectations

Morgan Stanley Predicts Yuan May Reach 6.70 Against Dollar in Near Term

Morgan Stanley sees room for the yuan to climb further, but disagrees with more bullish views that the currency is significantly undervalued. According to the bank's latest forecasts, the Chinese yuan may advance to 6.70 against the dollar in the near term, supported by stronger growth and improving risk sentiment. The bank also raised its year-end expectations for the yuan to 6.75 from 7 previously, bringing it more in line with the Bloomberg consensus.

The bank argues that much of the rally may already have played out, as the CFETS index, which tracks the yuan against a basket of trading partners, has returned to levels in line with recent years. This suggests that the "catch-up" phase after earlier weakness is over, according to chief China economist Robin Xing.

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The differing views come down to how investors interpret China's policy priorities. Bulls highlight strong exports, persistent trade surpluses, and improving investor sentiment as reasons the yuan could keep strengthening. Those more cautious say Beijing has little incentive to push for broad-based currency gains with domestic demand still uneven and external risks lingering.

Market pricing shows traders are now paying slightly more to hedge against yuan strength than they are against weakness. The so-called one-week risk reversals for the offshore yuan-dollar currency pair have fallen below zero to trade near the lowest since January, according to data compiled by Bloomberg. Even then, Morgan Stanley said the People's Bank of China is likely to remain wary of soft domestic prices, and is unlikely to use currency strength to address growth imbalances. This means that dollar-yuan would remain more of a function of broader greenback moves, it said in a report dated May 12.

The Chinese currency has risen almost 6% against the dollar in the past year, making it one of Asia's best-performing currencies. Both onshore and offshore rates climbed past the closely watched 6.8 per dollar level this week to their strongest since early 2023. The gains come ahead of a summit between Presidents Donald Trump and Xi Jinping in Beijing this week, which traders say could help sustain the trade detente supporting stocks and the yuan.