The Curiously Unpopular Case for RMB/CNY Appreciation

Remember the consensus view for 2025 that tariffs would force China (and other emerging markets) to devalue their currencies? The opposite happened, spectacularly so, with the Chinese Yuan (CNY) at its strongest level since November 2024 and emerging markets (EM) local currency debt up around 12% as of 7/30/25*. Return is calculated in USD; past performance may differ in your local currency. Returns may increase or decrease as a result of currency fluctuations. It should be noted that past performance is not a reliable indicator of future results. Investing is subject to risk, including the possible loss of principal, and EM local currency debt remains exposed to volatility, currency risk, and shifts in investor sentiment.

Why did this happen and what does it mean? CNY strength is a key component (among others). For China’s authorities, a stable or strong CNY is consistent with their goal of renminbi (RMB) internationalization. It supports consumers’ real incomes and wealth. It anchors inflation and expectations. Therefore, it addresses key imbalances and arguably makes a case for fiscal stimulus. It further contains trade war risks that would clearly arise should China simply devalue to compensate for tariffs. For many EMs, it means a new landscape of upward pressure on their currencies. We lay out the ongoing and surprisingly unpopular case for RMB appreciation below.

1. CNY is already cheap. Using the Bank for International Settlements (BIS) real effective exchange rate model (which simply measures value incorporating inflation differentials with trading partners), Exhibit 1 suggests that CNY may be undervalued by close to 30% on this basis. (The dollar is overvalued on this basis, and if we took the chart back farther you’d see it’s near record-high over-valuation on the BIS model.)

Exhibit 1 – CNY REER Cheap, USD Not

Real Effective Exchange Rates (REER) - USD and CNY

Source: BIS via Bloomberg LP. Data as of June 2025. REER measures a currency’s value against a basket of trading-partner currencies adjusted for inflation differences.

2. The roots of this CNY undervaluation – low Chinese inflation relative to US inflation – look set to continue. Exhibit 2 shows the evolution of the IMF’s Chinese and US inflation forecasts – China’s has been downward-revised and US’s has been upward-revised. This trend could lead to further USD weakness against CNY, and indeed signs of this have already been observed. We should add that the CNY’s strength and stability this year should reinforce China’s de-/dis-inflation dynamic, and USD weakness and volatility this year could reinforce or reignite the United States’ inflationary dynamic.

Exhibit 2 – US Inflation Forecast Rising, China’s Declining

Evolution of 2025 Inflation Forecasts
(Median, percent, year over year)

Source: IMF via Bloomberg LP. Data as of April 2025. EMDE stands for emerging market and developing economies; RHS refers to the right-hand scale.

3. China has significant net asset surpluses with the US (and the world), meaning it owns more USD assets than the US owns of CNY assets. The net international investment position is a popular way to measure this, now significant, imbalance. This represents a country’s total foreign assets minus its foreign liabilities. This is a balance sheet or stock measure, not a flow measure. We make this distinction because the primary response from economists was to analyze China’s balance of payments statistics to “solve” for the “flow” of Chinese exports. If that’s your framing, of course further CNY devaluation should have happened in order to boost exports and make imports dearer, because the economist is solving that problem. But, due to China’s NIIP (Net International Investment Position) it can manage the currency stronger, an option it didn’t previously have – it does not have to devalue and it has not been devaluing, in fact the daily foreign exchange (FX) fixes have been regularly stronger for CNY than the bank-predicted levels in 2025. So, what was/is the right economic analysis this time? We continue to think that the correct framework is that the stock of USD assets owned by China are what is being activated. China’s (and others’) USD assets are being sold and reshored to China or to other non-US shores. This is an opinion, as the data will speak more clearly later, but it seems to be the only explanation for what to many has been surprising strength in CNY this year. Other factors may also be at play, and the data will ultimately determine how sustainable this trend proves to be. (Speaking of external balance sheet strength, China and many EMs are net creditors in USD as well – they have more USD in reserves than government debt in USD, underlining credit quality in dollars.)

Large reserve shifts may heighten liquidity risk, currency volatility and valuation losses for investors in EM debt.

Exhibit 3 – China Owns More of US Than Vice Versa

Net International Investment Position - U.S. and China (bn USD)

Source: IMF via Bloomberg LP. Data as of June 2025.

4. People’s Bank of China (PBOC) is using fewer US Treasuries in reserves, and there’s more to go, arguably. You see the data and trend below. We would strongly observe that unlike global central bank’s as surveyed by the IMF, China’s reserves are still nearly four times their lowest levels, while global central bank holdings of US Treasuries are hovering at their lowest levels. This could point to further downside risk in Chinese ownership of US Treasuries, which in turn may contribute to upward pressure on US yields and/or downward pressure on the USD. Conversely, we should add that CGBs (Chinese Government Bonds) are increasingly demanded as reserve assets, but that process is intentionally opaque and will only be clear when it is established. We should also acknowledge that state bank holdings are reasonably looked at as part of the Venn diagram capturing central bank holdings, but we don’t think that’s worth delving into here. Also, when we are country economists, we do not take reporting of gold reserves too trustingly, but the true (higher) amounts likely reinforce our point. A final reference should be made to US sanctions risks which have clearly changed the attractiveness of US Treasuries to reserve managers, and which is especially alive in countries that could move to a more adversarial relationship.

Further reductions in U.S. Treasury reserves could increase market volatility, widen bid-offer spreads and reduce the liquidity of EM local-currency bonds. This is the gap between the price at which investors can sell and the price at which they can buy a security.

Exhibit 4 – China Is Already Reducing US Treasury Exposure

China's UST (United States Treasuries) Holdings, bn USD

Source: Bloomberg LP. Data as of June 2025.

5. The rubber hits the road on our NIIP framing because US dependence on fiscal financing (remember, the US borrows from China and Japan) should be reflected in a different risk/reward profile for onshore Chinese or Japanese Treasury buyers. One way of measuring this precisely is cross-currency swap spreads. These spreads show the cost of exchanging interest payments and principal in different currencies between two parties. An onshore Chinese or Japanese buyer will typically hedge any US Treasuries into CNY or JPY. But, given FX hedging costs (expenses paid to protect an investment from adverse currency movements), the hedge treasury in Japan pays around ¼ of the yield of a simple unhedged JGB (Japanese Government Bond). Another way to look at it is to use the NIIP framework to see how much higher US yields “should” be to incorporate this fact. We show this below, and it points to USD over-valuation/US Treasury over-valuation (yields too low).

Cross-currency hedging costs, interest-rate shocks and geopolitical tensions could erode returns and lead to capital loss for EM bond investors.

Exhibit 5 – What US NIIP Might Mean For US Rates/USD

A simple NIIP framework implies more USD weakness needed unless US yields rise more than peers

Source: Deutsche Bank, Bloomberg LP, Haver Analytics. Data as of June 2025.

6. Tariff game theory supports RMB appreciation. Let’s get a history lesson out of the way. If you expect official statements on currency arrangements, don’t hold your breath and don’t trade bonds or currencies. Given that many say we are in Nixonian times, we’ll refer to the Smithsonian Agreement of December 1971. This was negotiated for months prior to its announcement. Official references to currencies remain highly controlled if allowed at all, in all countries. So, the idea that the market will “know” with official clarity about currency arrangements is a non-starter, in our view. What’s our understanding? The simplest version is that key trading partners are being told that if they devalue after a trade deal (to be humorously extreme about it) would be a deal-killer. Reread that – you can’t weaken your currency and maybe you have to strengthen it if you don’t want another round of tariff trouble. We aren’t getting into the nature of the agreements which can be vague and weak or specific and strong…because they cannot be known, only surmised. But now further remember your pile of USD assets we noted in the NIIP above. So, you’re sitting on a net pile of USD and you know USD has to go down versus your own shore’s/currency’s assets. What will you do? Exhibit 6 has the answer: you bring your USD onshore or to other non-US shores). EM assets are reacting positively to Trump Tariffs v.2, and the market continues to scramble for an explanation.

It should be noted that unexpected shifts in inflation, policy intervention, or capital controls could trigger rapid RMB depreciation and losses for holders of EM local-currency bonds.

Exhibit 6 – Trump 1 Hurt EM, Trump 2 Helping…Why?

Source: VanEck Research, Bloomberg LP. Data as of June 2025.

7. This has significant positive implications for EM. There’s not just one currency cross anymore, CNY is more important to many EMs than USD. That said, individual country exposures vary widely, and factors such as domestic policy changes, political risk, or external shocks could offset these dynamics. Exhibit 7 shows a couple versions of this. On the left you see the China/EM trade balance rising secularly against the China/DM (developed markets) trade balance. On the right you see trade volume between China/EM surging above the volume of China/DM trade. There are obviously big country variations – Mexico is uniquely very exposed to the US, for example, whereas Chile and Brazil are much less so.

Exhibit 7 - CNY Is More Important than USD to Many EMs

Source: VanEck Research; Bloomberg LP. Data as of June 2025.

8. So you think China’s currency is risky; EM currencies, too? Well, if you think volatility is a measure of risk, Exhibit 8 indicates that CNY has shown relatively greater stability compared to JPY and USD during this period. It’s not the scope for this note, but we’ve written elsewhere about “fiscal dominance” characterizing many DMs – government debt is so high that monetary policy loses meaning and traction, which we see as underneath this volatility in DM currencies. We add a bonus Exhibit 9 showing how all of EM local bond market volatility appears to be in a similar regime now relative to higher DM bond volatility. This underlines the centrality of CNY for EMs more broadly. Note that currency stability supports Chinese authorities’ objective of internationalizing the RMB, increases consumers’ real income and wealth, and anchors inflation and inflation expectations. It also, to our conjecture, prevents upsetting a US that would surely retaliate if the currency was simply devalued to compensate for tariffs.

Currency stability can reverse quickly and sudden bouts of volatility may lead to significant mark-to-market losses in EM local-currency debt portfolios.

Exhibit 8 – CNY Stable Versus USD and JPY

Exchange Rate volatility Trends (CNY vs JPY)

Source: Bloomberg LP. Data as of July 2025.

Bonus Exhibit 9 – EM Local Bonds Less Volatile Than DM Bonds

EM Local Bonds vs DM Sovereigns - 90-day Total Return Volatility (%)

Source: VanEck Research, Bloomberg LP. Data as of July 2025.

The evidence for potential Chinese currency appreciation in 2025 is building. A structurally undervalued CNY, persistent inflation divergence with the U.S., and China’s strong external balance sheet may support a stronger currency. Meanwhile, de-risking from U.S. Treasuries and growing trade ties between China and EMs are redefining global FX dynamics. In this context, CNY stability is not only consistent with China’s policy goals—it may be central to a new era of EM financial strength.

Capturing the Potential Shift in Emerging Markets

The case for RMB strength in 2025 is part of a broader shift that has clear implications for emerging markets. Against this backdrop, VanEck J.P. Morgan EM Local Currency Bond UCITS ETF (EMLC) provides investors with a way to access the sovereign bond markets of a wide range of EM countries in their local currencies. For those looking to diversify portfolios, capture yield, and potentially benefit from the new FX dynamics led by the CNY, this UCITS fund may offer a liquid, transparent, and index-based solution.

At the same time, investors should be mindful of the risks. Exposure to emerging markets local currency bonds involves currency risk, credit risk, political and economic instability, and periods of heightened volatility and lower liquidity. Market risk, interest rate sensitivity, and potential drawdowns are inherent to this asset class. As always, past performance is not a reliable indicator of future results. Investors must consult the Key Investor Information Document (KID) and the prospectus prior to investing, as these documents contain important details on objectives, costs, and risks.

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