China's yuan briefly hit its highest level against the U.S. dollar since the launch of a modern Chinese currency trading system in 1994, a remarkable turnaround from its slump earlier this year but one that the government will likely cap to protect China's crucial export sector.
Traders and analysts attributed the recent rally to renewed weakness in the dollar in the wake of the latest round of bond purchases launched by the U.S. Federal Reserve, in a move known as quantitative easing. The Fed's move has pushed down the value of the dollar and led investors to plow capital into emerging markets, such as China, to seek higher returns.
Further aiding the yuan's push: domestic businesses dumped dollars for the yuan on speculation that China will take more monetary-easing measures to arrest the economic slowdown that has raised worries over potential factory closures and job losses. Such a move would typically put short-term downward pressure on the yuan, but any increase in optimism over the Chinese economy could strengthen the currency.
The speculation was triggered by a record amount of cash injected into China's banking system by the central bank this week, as well as the approach of next week's weeklong National Day holiday.
"People don't want to be short of the renminbi during the weeklong holiday in case the government announces any measures to stimulate the economy," WoonKhien Chia, a currency analyst at the Royal Bank of Scotland, referring to the yuan's other name.
Many market players, however, expect the bounce in the yuan to be short-lived as Beijing comes under growing pressure to bolster its economy ahead of a once-a-decade leadership transition set to begin in November. A cheaper yuan makes Chinese goods sold overseas less expensive in dollar terms.
China's central bank, the People's Bank of China, "could still try to push down the yuan's value to help Chinese exporters," Ms. Chia said, adding that she doesn't expect the yuan's strong rally to last the next couple of months.
The yuan has experienced rare ups and downs this year as China moved to let market forces play a bigger role in deciding its value. It consistently weakened against the dollar early this year after a year and a half of appreciation, falling as much as 1.6% against the greenback in late July.
Since then, the Chinese currency has reversed course, and it reached the strongest level since modern trading began in 1994 against the dollar on Friday, at 6.2835 to the dollar. The yuan, which ended at 6.2849 versus the dollar, is now up 0.14% this year. It has risen nearly 32% against the dollar since Beijing dropped its peg to the U.S. currency seven years ago.
The PBOC maintains a tight grip on the yuan's value by setting a daily rate for it, known as the parity rate. In April, it widened the range in which the yuan is allowed to rise and fall in daily trading, to 1% above or below the parity rate from 0.5% previously. The move was a signal that China believes the currency is fairly valued and ready to take a more prominent role globally.
"An interesting phenomenon we're seeing is that the yuan has become more volatile since April, indicating a more market-driven currency regime," said Beng-Hong Lee, Deutsche Bank AG's head of trading in China.
Despite the yuan's strong bounce Friday, many traders pointed out that the 6.3410-to-the-dollar parity rate set by the PBOC before the day's trading began showed that it still guided the yuan weaker than its closing level of 6.2940 at the end of last year, indicating the central bank's desire to keep the yuan from appreciating too fast against the dollar.
Until late last year, when China's slowing economy began to weigh on the yuan, the PBOC had frequently intervened in the currency trading to prevent a sharp jump in the yuan's value. Some traders say the central bank could renew its intervention in the coming weeks should the yuan continue to rise sharply.
In addition, Beijing has its eyes trained more than just the dollar. The European Union so far this year has been China's No. 2 export market after the U.S., and China is believed to also have the incentive to prevent the yuan from appreciating too much from the euro. By reducing the value of the yuan against the dollar, the PBOC could slow the rise of the yuan against the euro, analysts say.
But any fall in the yuan is bound to keep it a political issue in the U.S. during an election year in which the Obama administration continues to publicly push China to let its currency appreciate. Some U.S. businesses and lawmakers have accused Beijing of keeping the yuan artificially weak to help its exporters.
Meanwhile, Republican presidential challenger Mitt Romney has said he would name China a "currency manipulator" if elected.
