As the year ends and another begins, fluctuations in both the onshore and offshore renminbi (RMB) exchange rates have intensified, with the onshore exchange rate briefly sinking below the critical 7.3 markAccording to Guan Tao, the chief economist at China Merchants Bank, these recent depreciations are primarily attributed to a strengthening U.SdollarSince October 2024, the dollar has consistently reached new highs as expectations surrounding the Federal Reserve's monetary policies shifted towards a more accommodative stanceMoving into 2025, this dollar strength continues, placing considerable pressure on non-U.Scurrencies worldwide.

Guan further elaborates that the dollar outlook is neither linear nor one-sidedThe Federal Reserve's policies will oscillate between the risks of insufficient tightening and excessive tightening, leading to a dollar index that fluctuates by market sentiment

As traders grapple with these dynamics, both the market's short-term mood and broader economic indicators will dictate the dollar's trajectory, providing a conducive environment for bi-directional volatility in currency values.

From the perspective of Wen Bin, the chief economist at Minsheng Bank, the dollar index has displayed a trend of oscillation upward since the beginning of 2024, with most non-U.Scurrencies following a path of depreciation during this timeAdjustments in market expectations regarding interest rate cuts by the Federal Reserve have resulted in a rocky path for the dollar index, leading to renewed strength in the U.SdollarThis volatility has also contributed to significant fluctuations in the RMB exchange rate

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During the first half of the year, the RMB faced considerable external pressure to depreciate amidst a strengthening dollar index and widening interest rate differentials between China and the United States.

However, it is notable that the depreciation of the RMB against the dollar has been significantly less severe compared to the advances in the dollar indexAlthough the RMB depreciated by approximately 2% against the dollar from the beginning of the year until the end of November, the CFETS RMB exchange rate index indicates a cumulative increase of 2.7% over the same periodThis demonstrates that the RMB has actually strengthened when measured against a basket of currencies, reflecting a more stable positioning in the global financial landscape.

The People's Bank of China (PBOC) and the State Administration of Foreign Exchange have been communicating a strong commitment to stabilizing the RMB exchange rate in recent meetings.

Since the beginning of 2024, macroeconomic adjustments have intensified, creating a favorable monetary and financial environment conducive to economic recovery

In this context, the supply and demand dynamics in the foreign exchange market have generally stabilized, with a steady current account surplus and adequate foreign exchange reserves, resulting in a balanced two-way fluctuation of the RMB exchange rate at a fundamentally stable level.

Looking ahead, efforts will be made to strengthen the resilience of the foreign exchange market, stabilize market expectations, enhance market management, and decisively address any behaviors that disrupt market orderThere is a determination to prevent the emergence of unidirectional expectations that could become self-fulfilling while mitigating risks associated with excessive exchange rate movements, maintaining the RMB exchange rate at a reasonable and balanced level.

Reports indicate that the PBOC has consistently highlighted the necessity to mitigate risks of excessive exchange rate adjustments during its quarterly meetings throughout 2024. Each of these meetings underscored the importance of preventing the establishment of persistent unidirectional expectations

In contrast to prior quarters, the fourth quarter meetings emphasized the need to decisively address disruptive market behaviors.

The Central Bank's work conference for 2025 highlighted that the comprehensive policies implemented in 2024 have preserved the basic stability of the RMB exchange rateMoving into 2025, there will be a continued commitment to the prudent management of foreign exchange reservesFurthermore, the national foreign exchange management work conference emphasized efforts in the new year towards high-quality development of foreign exchange reserve management, ensuring the safety, liquidity, and value preservation of foreign exchange assetsAdditionally, there will be intensified efforts to maintain basic stability in the foreign exchange market, enhance monitoring and assessment of market conditions, and deploy counter-cyclical adjustments in foreign exchange management to mitigate external shock risks.

Guan Tao believes that maintaining the RMB exchange rate at a reasonable and balanced level does not imply a fixed rate

Since December 2024, discrepancies in the trading prices of the RMB relative to the midpoint price and those in foreign markets have widened, indicating increased depreciation pressures and expectationsIt is vital to allow exchange rates to remain flexible, thus responding to shocks in a manner that properly reflects normal market conditionsThis flexibility aids in relieving market pressures and addressing exchange rate expectationsThe market's improved adaptability and tolerance for fluctuations enhances the resilience of the foreign exchange market, instilling confidence in its ability to maintain exchange rate stability.

Diverse Tools Support a Stable Foreign Exchange Market in 2025

According to recent research by CICC, the trends in the foreign exchange market in 2025 will heavily depend on the fluctuations of two key variables: interest rates and risk appetite

Importantly, changes in Federal Reserve policy expectations are likely to remain the primary influence on fluctuations in the dollar exchange rateThe dollar may experience a trajectory characterized by a decline followed by a recovery, initially appearing low before peaking later in the year.

As 2025 begins, a new wave of interest rate cuts could push the dollar further down from its current levelsIn a baseline scenario of stable Chinese economic performance, external factors are expected to continue influencing the trajectory of the RMB exchange rate throughout the year, particularly the evolving U.S.-China trade policies and interest rate differentials stemming from the Federal Reserve's easing stanceFrom a yearly perspective, there may still be opportunities for the RMB to rally from lower levels early in the year, especially since tariffs may not have fully materialized yet, and the Federal Reserve is still in a cycle of rate cuts

However, over time, increased tariffs and a rebound in U.STreasury yields could potentially exert downward pressure on the RMB exchange rate.

Nevertheless, the PBOC's stabilization measures will lend support to exchange rate expectationsThroughout 2024, RMB exchange rate expectations have remained relatively stable, signifying the important role that stabilization policies have playedWith repeated emphases on "resolutely preventing excessive exchange rate adjustments," the central bank continues to underscore its commitment to maintaining stable expectations regarding the exchange rateThis proactive stance in 2025 is likely to limit the depreciation potential of the RMB.

Wen Bin also pointed out that strong economic fundamentals and a diverse set of management tools will be sufficient to ensure stable exchange rate behavior

The third quarter monetary policy execution report reiterated the necessity of "resolutely preventing excessive exchange rate adjustments" and "preventing the formation of self-reinforcing unidirectional expectations," reflecting that maintaining exchange rate stability remains a key policy focusGiven the extensive range of exchange rate management tools at China's disposal, it is quite feasible to uphold basic stability for the RMB at reasonable levelsOverall, while significant fluctuations in the dollar index will inevitably lead to bi-directional movements in the RMB exchange rate, robust economic fundamentals, a rich toolkit for exchange rate management, and markedly enhanced resilience in China's foreign exchange market all collectively reinforce the capacity to maintain the RMB at a fundamentally stable equilibrium.