Summary of the Key Points
In the first half of this year, despite the unfavorable circumstances of the US dollar appreciating and the widening interest rate gap between China and the United States (Chinese government bonds offering lower yields than American ones), the RMB strengthened against the trend, sparking discussions about the onset of a "new appreciation cycle." However, by drawing on historical lessons from the failed "new cycles" in 2021, the author analyzes three current short-term factors that are supporting the RMB's appreciation (improved macroeconomic conditions, improved Sino-US economic and trade relations, and strong external demand), as well as five potential risks that could reverse this trend in the future (the direction of the US dollar, the pain associated with the transition between old and new growth drivers, fluctuations in the external environment, the reliability of purchasing power parity, and the effects of macroeconomic tightening). The author concludes that while a short-term appreciation is a reality, claiming a "new cycle" is premature and advises market participants to manage exchange rate risks, while regulatory authorities should maintain exchange rate stability.
Detailed Analysis
Why Did the RMB Strengthen Against the Trend in the First Half of the Year?
In the first half of this year, the US dollar index rose by 3%, making the US dollar more valuable. The interest rate gap between two-year government bonds between China and the US widened by 74 basis points (Chinese yields were even lower). Nevertheless, the RMB appreciated: the domestic central parity rate increased by 3.2%, and the spot exchange rate rose by 3%, outpacing the rise in the offshore RMB. As a result, the index measuring the RMB's performance against a basket of currencies (CFETS) increased by 4.7%, reaching its highest level since August 2022. In other words, although the US dollar was stronger, the RMB performed even better.
This is somewhat similar to what happened in 2021: the US dollar was strong, but the RMB also appreciated, though that trend did not last long.
Is the "New Appreciation Cycle" Credible? Let's Look at Historical Lessons
Every time the RMB appreciates for a period of time, people claim that a "new cycle has begun," but past experiences have been disheartening:
- From June to December 2020, the RMB rose by 9.3%, and in 2021, there were hopes of a new cycle. However, the US economy recovered quickly, inflation increased, and the interest rate gap between China and the US narrowed, causing the RMB to stop rising and stabilize at around 6.37 (not falling below the 6% range).
- From May to December 2025, the RMB rose by 3.9%, but then it fell by 14.1% in March 2022, lasting for a total of 38 months.
The author points out that previous "new cycles" either had limited appreciation or were short-lived. Given that the real economy is a slow-moving factor while exchange rates are more volatile, experts often miscalculate, so it's best not to be too optimistic about a new cycle.
Three Short-Term Positive Factors Supporting the RMB's Appreciation
There are three reasons why the RMB was able to strengthen against the trend in the first half of the year:
1. Improved Macroeconomic Conditions: Previously, concerns focused on real estate, local government debt, and deflation. Now, there is optimism about rising prices, technology (AI, new productivity), and trendy consumer trends. The growth in the ChiNext index (35%) and the STAR 50 index (64%) suggests that markets have confidence in China's new economy.
2. Improved Sino-US Economic and Trade Relations: After Donald Trump returned to office, the two countries held six talks and removed some tariffs. High-level meetings set a tone of stabilizing relations. In May this year, Chinese exports increased by 35.4% and imports by 20.4%, indicating stable trade ties.
3. Strong External Demand: Global investment in AI is on the rise, and China's imports and exports have both grown significantly. Although the trade surplus decreased by 3.9%, it remains at a historically high level (2.36 times that of the same period in 2021). The IMF has even raised its economic growth forecast for China, partly due to strong export performance. A trade surplus and expectations of appreciation can reinforce each other: as demand increases, so does the exchange rate.
Five Potential Risks That Could Cool Down the RMB's Appreciation
Despite these short-term positives, there are several long-term uncertainties:
1. Pressure from the US Dollar: The current negative interest rate gap between China and the US means that holding RMB assets yields less than holding US dollars, leading to foreign capital selling Chinese bonds. The Federal Reserve may continue to maintain high interest rates, keeping the US dollar strong and putting pressure on the RMB.
2. Painful Transition Between Old and New Growth Drivers: Issues with old industries (real estate, local government debt) have not been resolved, and new industries (technology) have not yet taken over completely. As a result, foreign investment in Chinese assets is lower than before.
3. Unstable External Environment: Conflicts in the Middle East, fragmentation of global trade, potential tech bubbles, and high levels of debt could lead to a global economic recession, affecting China's exports and causing the RMB to weaken.
4. Reliability of Purchasing Power Parity: Some argue that based on purchasing power parity (the relative value of currencies when buying the same goods), the RMB should appreciate. However, the Japanese yen and Singapore dollar have long been trading below their purchasing power parity by 30%-60%, so this may not be a reliable indicator in the short term.
5. Macroeconomic Tightening Effects: China currently has a net external debt position (it owes more to others than it owes them). An appreciating RMB could lead to losses in trade and finance, which contradicts policy objectives and may make markets more sensitive to such changes.
Conclusion: Avoid Betting on Unidirectional Appreciation and Manage Risks
The author advises:
- Market Participants: Don't assume the RMB will always appreciate; manage exchange rate risks (e.g., use derivatives to hedge). Avoid misaligning your asset portfolio (e.g., borrowing US dollars to repay in RMB) to prevent losses.
- Regulatory Authorities: Maintain stable market expectations and allow the exchange rate to fluctuate within a reasonable range, avoiding extreme rises or falls.
In summary, while a short-term appreciation of the RMB is a fact, it's premature to talk about a "new cycle." It's important to be cautious and manage potential risks.