China's yuan slips, traders wary of reopening risks

China's yuan weakened on Tuesday as the dollar gained broadly, with sentiment also curbed by growing caution that the recovery in the world's second-biggest economy could be gradual and bumpy even as Beijing eases strict COVID policies.

Despite the recent rebound triggered by economic reopening hopes, the yuan will remain under depreciation pressure next year, some analysts argue.

The spot yuan USDCNY slipped 0.2% to 6.9738 per dollar around midday, despite the central bank setting the guidance rate USDCNY at a two-month high.

Still, the Chinese currency has jumped nearly 5% against the dollar since November on expectations of an eventual reopening of China's economy.

Maybank attributed the yuan's weakness on Tuesday to an overnight rebound in the U.S. dollar triggered by unexpectedly strong economic data.

U.S. data, including October factory orders and durable goods orders "surprised to the upside and halted the momentum of USD bears." The dollar index DXY bounced 0.7% overnight from a five-month low.

Sentiment was also eroded by growing concerns over the risks from eased COVID curbs in China.

"Ending zero-COVID is encouraging and should be quite positive for markets, but we caution that the road to reopening may be gradual, painful and bumpy," Normua said in a note to clients.

"China does not appear to be well prepared for a massive wave of COVID infections, and it may have to pay for its procrastination on embracing a 'living with COVID' approach."

Bart Wakabayashi, branch manager at State Street in Tokyo, said the past week has been dominated by expectations of some relief from the zero-COVID policy, which pose broad implications for global trade and supply chain issues.

"I think there's been a lot of speculative yuan buying for those reasons, and the market will continue to be driven by whatever media headlines we get on variations of China's zero-COVID policy."

CIB Research analysts defined the recent yuan strength as a rebound, rather than trend reversal, arguing that sustained strength requires China's shift toward monetary tightening, and a sharp drop in U.S. interest rates.

The yuan is under depreciation pressure over the long term, so "don't be in a hurry closing dollar exposure around the Chinese New Year," they said in a note to clients.

The yuan market at 3:34AM GMT:

ONSHORE SPOT:

*Divergence of the dollar/yuan exchange rate. Negative number indicates that spot yuan is trading stronger than the midpoint. The People's Bank of China (PBOC) allows the exchange rate to rise or fall 2% from official midpoint rate it sets each morning.

OFFSHORE CNH MARKET

*Premium for offshore spot over onshore USDCNY

**Figure reflects difference from PBOC's official midpoint, since non-deliverable forwards are settled against the midpoint. USDCNY.