SINGAPORE (Reuters) – Financial markets are betting that China will not operate the yuan as a policy tool to offset expected U.S. tariffs during Donald Trump’s second presidency, based on the view that a keen depreciation like the one seen during his first term would be more damaging than helpful for the struggling economy.

From yuan futures pricing to interest rate derivatives and analyst forecasts, all indications are that China is already allowing the yuan to depreciate slowly to adjust to a much stronger dollar in preparation for Trump 2.0.

However, prices also show that investors expect a gradual, moderate depreciation, with sell-side analysts seeing a decline of 5-6% from current levels by the end of the year.

During Trump’s first term as president, from March 2018 to May 2020, the yuan may have weakened by more than 12% against the dollar as a result of a series of tit-for-tat Sino-U.S. tariffs.

Trump has threatened tariffs of up to 60% on imports of Chinese goods during his second term starting Monday, although some reports suggest the tariffs could be gradually increased.

However, the situation is different now, analysts say. The yuan is already frail, the economy is feeble, wallet money is leaving China, and its exports to America make up a smaller share of total world trade and are too compact to justify a vast devaluation.

The yuan, or renminbi as it is also known, has been hovering near 16-month lows against the dollar for several days now and has fallen for three years in a row. In 2018, it was close to a record high of 6.3 per dollar.

Last month, Reuters reported that there were discussions in official circles about allowing it to fall to 7.5 per dollar, a decline of about 2% from the current level.

However, most of this depreciation will likely come from interest rate differentials between the U.S. and China, which have increased to about 300 basis points.

The dollar is already elevated at its current level of around 7.3 yuan and “breaking that level much higher is unrealistic,” said Ju Wang, head of Greater China currency and pricing strategy at BNP Paribas (OTC:).

Wang pointed out that almost half of China’s $1 trillion trade surplus was accounted for by countries other than the United States, particularly neighboring countries such as Vietnam, which have become hubs for finishing China’s manufactured goods.

In both 2015 and 2019, when the yuan fell sharply, China was forced to defend its policy and explain that it was not using any beggar-thy-neighbor currency devaluation tactic. A cheaper exchange rate helps exporters by making their prices more competitive internationally.

“There is a responsibility on China’s side to maintain a relatively stable currency as it still enjoys a fairly large trade surplus with the rest of the world. The world cannot agree to a one-for-one dollar-yuan adjustment on tariffs, Wang said.

Asked about the yuan, the People’s Bank of China (PBOC) told Reuters on Friday that the country had sufficient foreign exchange reserves and greater experience in responding to external shocks … “therefore has the confidence, conditions and ability to keep the renminbi exchange rate broadly stable at a reasonable level balance.”

STABILITY IS KEY

Domestic considerations related to a sluggish economy also require a stable financial system and currency to prevent residents and businesses from shifting their savings abroad.

Falling domestic bond yields and uncertainty in stock and real estate markets have accelerated the rush to accumulate dollars.

“If the renminbi becomes a very unstable currency, people will try to convert it to US dollars, buy gold, etc. And that’s not what the PBOC wants,” said Vincent Chan, China strategist at Aletheia Capital.

While the PBOC’s plans for the yuan have been complex to interpret, the PBOC has made every effort to contain the currency’s weakness to the point that it remains mighty on a trade-weighted basis.

The trade-weighted yuan index, which measures the Chinese currency against a basket of 25 competitors, is hovering near its highest level in more than two years, showing that the yuan remains slightly less competitive so far than the currencies of its trading partners.

The authorities have set a floor for falling domestic yields, including by suspending the bond purchase program. They encourage companies to borrow abroad to attract more dollars into the country, and the central bank has often set the yuan’s trading range at a level higher than market expectations.

While China’s leaders pledged in December to loosen monetary policy and take other steps to support economic growth in 2025, interest rate swaps show markets are pricing in the chances of interest rate cuts as they believe the PBOC will prioritize yuan stability .

Alpine Macro Yan Wang, China strategy specialist (BCBA:), considers the level of 7.7 in the dollar/yuan ratio as the upper limit for PBOC, which means a further decline of 5%.

“Pressure on the yuan in the near term may be difficult to avoid,” said Vishnu Varathan, director of macroeconomic research for Asia and former Japan Mizuho (NYSE:). “However, it can be managed in such a way that the trade-weighted stability of the yuan is not unduly threatened.”

($1 = 7.3317 renminbi)