Recent movements have seen the onshore yuan approach the 6.70 high last recorded in 2023, reigniting debate over whether the currency is undervalued. CITIC SEC analysts argue such assessments often rely on an overweighted trade balance component, whereas the more significant shifts are occurring at both ends of the yuan's pricing mechanism.
Externally, rising long-end US Treasury yields, the US Treasury's bond buyback program capping long-end pressure, and coordinated US-Japan intervention in the yen all point to growing market concerns over dollar creditworthiness, which could cap any dollar index rebound and provide a tailwind for yuan appreciation. Internally, the dominant factor driving the yuan is shifting from interest rate differentials back to trade flows, meaning this appreciation cycle reflects a reweighting of pricing factors rather than correction of undervaluation. With a substantial stock of outstanding foreign exchange settlement obligations, the zone between the static break-even line and dynamic cost line for holding dollars is where settlement intentions amplify progressively.
Furthermore, extrapolating from the central bank's statement that the exchange rate sits in a "mid-range zone" for recent years, and based on historical ranges since the 2005 reform, the mid-range zone likely spans 6.6-7.0, which may also represent the current policy-consistent band. This week's focus falls on July fiscal data and a State Council Information Office press conference, while next week attention turns to the Jackson Hole global central bank symposium, US July PCE inflation, and China's August PMI readings.
Where the undervaluation debate stands
In discussions of "yuan undervaluation," observations based on absolute purchasing power, the divergence between nominal and real effective exchange rates, and export competitiveness all imply the currency needs to appreciate, but the undervaluation is largely a measurement issue. First, absolute purchasing power metrics indicate undervaluation of roughly 37% (or about 24% after adjusting for per-capita GDP), yet this reflects cost differences in non-tradeable goods. Second, the divergence between nominal and real effective exchange rates (nominal at the 100th percentile, real at only the 66th) stems from weak domestic price pressures. Third, export competitiveness metrics show undervaluation of only about 1%.
Overseas institutions' calculations of yuan undervaluation are more reliant on strong assumptions that the current account dominates pricing with low weight on interest rate differentials. It must be emphasized that model-based exchange rate estimates carry more theoretical than practical significance, as actual yuan movements are constrained by pro-cyclical foreign exchange settlement, capital account management, central parity guidance, and multiple policy objectives.
External monetary environment supports yuan strength
From an external monetary perspective, accumulating dollar credit concerns are likely to limit dollar index upside and serve as a supportive tailwind for the yuan. First, the rolling correlation coefficient between the yuan and dollar index has dropped from 0.80 in November 2025 to -0.48 in August 2026, marking the third "decoupling" since the exchange rate reform, indicating diminished dollar index influence on the yuan.
Second, in late July, the US and Japan jointly intervened in the yen for the first time in 28 years, with Washington citing "significant yen undervaluation" as justification. However, the intervention was conducted using euro purchases and tied to the FIMA repo facility to prevent Japan from selling US Treasuries, effectively protecting the Treasury market and fiscal sustainability. The US also voiced concerns over yuan undervaluation, though China's response is likely to focus on structural policies such as expanding opening-up and imports rather than exchange rate concessions.
Third, global investors have not abandoned dollar assets, with foreign private investors net purchasing $490 billion in US Treasuries in the first half. They appear to be shortening duration, reducing long-end exposure, and holding gold or modest crypto assets to hedge rising sovereign credit risk. Combined with the 30-year Treasury yield touching 5.34%—a near 19-year high—and Treasury buybacks reinforcing "fiscal dominance" expectations, the dollar index is likely to remain rangebound this year, with weak European and Japanese fundamentals supporting the floor while credit concerns cap rebound potential.
Internal pricing mechanism shifts from spreads to trade
On the internal pricing front, the dominant factor driving the yuan is shifting from interest rate differentials back to trade, though the deeply inverted China-US spread still influences the pace of appreciation. In terms of correlation, the single-factor explanatory power of the China-US spread has contracted from 88% during 2022-2024 to just 1% since 2025, while the rolling surplus factor has risen to 0.50 with high significance. The annual correlation coefficient between the exchange rate and spread has flipped from -0.97 to 0.94.
The yuan's decoupling from the dollar index movement, with its independent trajectory, confirms this reweighting of pricing factors. China's trade fundamentals remain solid: the 12-month rolling goods trade surplus stands at a historic high of $1.19 trillion, suggesting trade support for the exchange rate has short-term fundamental persistence. However, given the high synchronization between exports and US import demand, sustainability remains constrained by the external demand cycle itself.
It should be noted that while the China-US spread no longer determines exchange rate direction at this stage, the roughly 300 basis point deep inversion still affects the appreciation slope and opportunity cost of holding dollars. Given expectations of limited further appreciation, the yield advantage of holding foreign currency relative to settlement has not yet disappeared.
Policy-consistent mid-range zone likely 6.6-7.0
Looking ahead, yuan appreciation direction remains intact, but extrapolating from central bank communications, the policy-consistent "mid-range zone" is likely 6.6-7.0. Since 2022, cumulative surplus-related dollar positions weighted average entry point stands at approximately 7.04, with bank client-side outstanding settlement estimated at $760 billion at an average entry of 7.16. Monthly data shows enterprises still wavering between settlement and holding (exceptional over-settlement in March, followed by $42.4 billion in new holdings in July).
On the cost side, the current static break-even exchange rate for client positions is estimated at approximately 6.57, with the dynamic holding cost line at about 6.79. The current spot rate sits between these two levels, meaning settlement intentions amplify progressively as the spot rate strengthens. From a policy perspective, extrapolating from the "mid-range zone" statement, and based on historical ranges since the reform, the mid-range zone likely spans 6.6-7.0, representing the current policy-consistent band.
Going forward, appreciation direction remains unchanged, with the slope likely continuing to be managed by the central bank. Key indicators to track include volume expansion in foreign exchange settlement, the interaction between long-end Treasury yields and Treasury buybacks, and yen intervention developments.
Fiscal spending still has room to accelerate
July fiscal revenue growth hit a new high again, with tax collection accelerating further. Corporate income tax, personal income tax, and value-added tax were the most significant incremental contributors. Fiscal expenditure growth notably slowed in July, with local government spending turning negative. Infrastructure-related spending declined overall, though agriculture, forestry, and water conservancy spending accelerated. Government-managed fund revenues and expenditures both showed marked marginal improvement, with revenue growth improving 11.9 percentage points from June and expenditure improving 15 percentage points. Land-related fiscal revenue improved 15 percentage points, mainly due to the low base from the previous month. New special bond issuance reached 341.2 billion yuan, though the pace slowed again.
Through July, general public budget revenue completed 65.1% of the annual target and expenditure 54.3%. Government-managed fund budget revenue completed approximately 31.4% and expenditure around 38.3%, with overall progress still slower than the same period last year. Combined general budget expenditure with new special bonds and ultra-long-term special treasury bond issuance totals 19.5 trillion yuan, leaving 16.3 trillion yuan remaining—the highest year-end inventory level on record. Looking ahead, the fourth quarter may see incremental policies such as activating local government bond quota headroom. New policy measures including accelerated deployment of new policy-based financial instruments, activation of local bond quota balances, and coordinated fiscal-financial initiatives are key developments to watch.
Risk factors
Risks include the Federal Reserve tightening monetary policy beyond expectations; significant long-end US Treasury yield increases triggering global financial market turbulence; geopolitical and tariff policy volatility; domestic fundamental recovery falling short of expectations; and concentrated foreign exchange settlement by exporters causing exchange rate overshooting.