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The trend is yuan’s friend but watch for speed bumps

We liked the yuan before China was cool, as the country song goes. When the yuan traded at 7.2 to the dollar last June, the brokerage-house consensus held that it would depreciate to around 8.0 to the dollar. With the yuan trading around 6.75 in the offshore market, most financial commentators see nothing but upside.

So do we, with a short-term caveat, namely the one we highlighted in last week’s Global Value Strategist: Rising US real interest rates create headwinds for risk assets around the world, including China’s currency.

Real rates are rising in the US because the Federal Reserve has nailed the overnight rate to the zero line, which means that falling inflation expectations translate into higher real rates. Perversely, that increases the real cost of money when the economy weakens.

In fact, the weakening US economy and continued strength in China’s economy portend a rising yuan. But the monetary anomaly created by Fed policy sometimes pushes against this trend.