China's offshore yuan hits strongest in four years ahead of Trump-Xi meeting

SHANGHAI, Sept 18 (Reuters) - China’s offshore yuan on Friday hit the strongest level against the dollar in four years, as traders bet this week’s US rate hike has not derailed the yuan’s appreciation cycle.

In the onshore market, the yuan strengthened about 0.15% and is on track for its third straight weekly gain, as traders await next week’s meeting between US President Donald Trump and Chinese leader Xi Jinping, which could ease some trade tensions.

Bank of America forecast the yuan to firm another 1.6% by the end of this year.

“Export proceeds conversion and an undervalued CNY are the key drivers for this view, as well as increasing pressure from the G7 to address trade imbalances,” it said in a note.

Offshore yuan hit 6.6956 per dollar in morning trade, the strongest level since July, 2022.

In the onshore market, the yuan changed hands at 6.6983 per dollar in late morning trade, the strongest level since January 2023.

The dollar index gained earlier this week ahead of Wednesday's rate hike by the U.S. Federal Reserve, but the rally eased on Friday.

Nanhua Futures said that the U.S. has entered a rate hike cycle, "but the yuan's path of appreciation has not ended".

The yuan will continue to strengthen, bolstered by China's strong experts and year-end settlement of dollar receipts, the brokerage said.

Lynn Song, ING's Greater China chief economist, agreed that the yuan’s trajectory has derailed from its close correlation with US-China yield spreads over the last year.

“This is largely thanks to the high quantities of foreign exchange being held by Chinese exporters over the past few years, and the shift toward CNY appreciation expectations," Song said.

"Fewer companies are willing to chase the yield spread for fear of losing out in the currency movement side."

The caveat, however, is that if the Fed becomes more hawkish, "eventually the yield spreads should widen to a level which tempts more investors back to the market, and places depreciation pressure on the CNY”.

Another potential source of downward pressure on the yuan is China’s deflationary risks, according to Bank of America.

“Weak domestic demand does help to keep the current account surplus high, but it also brings debt deflation risks with it, which could trigger capital outflows under a stress scenario.”