Since mid-June, a noticeable shift has occurred in the foreign exchange market. The US dollar index has surged, buoyed by unexpectedly hawkish signals from the Federal Reserve, while the Chinese yuan has undergone a phase of retracement.
The US dollar index continued its climb to 101.5 on June 25th before slightly retreating to 101.36 on the 26th. Corresponding adjustments were seen in exchange rates. At the close on the 26th, the onshore yuan was quoted at 6.7978 against the dollar, while the offshore yuan was at 6.8048.
The yuan, which had been strengthening consistently, has now returned to the 6.8 range, driven by the dollar's rapid rebound. This has intensified market discussions regarding the yuan's potential for further appreciation and its subsequent trajectory.
Fed's Hawkish Signals
The primary catalyst for the yuan's shift from appreciation to depreciation stems from the unexpectedly hawkish signals released during the latest Federal Reserve policy meeting. The Fed's Summary of Economic Projections revealed that officials' median forecast for the federal funds rate in 2026 was raised to 3.8% from the 3.4% projected in March.
An analysis suggests that the hawkish tone from the Fed's first meeting chaired by the new leader on June 16th provided significant support for the dollar, outweighing the impact of reduced safe-haven demand following a US-Iran memorandum of understanding signed on the 15th. This propelled the dollar index from 100.4 on June 17th to 101.5 by the 25th.
On the evening of June 25th, US data showed the May Personal Consumption Expenditures (PCE) price index rose 4.1% year-on-year, up from 3.3% in April, marking the first time it has breached the 4% level in nearly three years. Rising energy prices were a key driver of the overall inflation rebound. Meanwhile, the core PCE price index increased by 3.4% year-on-year, edging up from the previous 3.3% to reach its highest level since October 2023, indicating persistent price pressures in US services. This has led markets to widely believe the Fed will find it difficult to pivot to an easing policy in the near term.
According to the CME FedWatch Tool, the market currently prices in approximately a 59.4% probability of a Fed rate hike at the September policy meeting.
Some viewpoints suggest that the Fed's potential return to a rate-hiking cycle, combined with ongoing geopolitical disturbances, could lead to a resurgence of dollar strength, potentially bringing the current phase of yuan appreciation to an end.
However, this perspective may be somewhat one-sided. Analysis indicates that the yuan has been demonstrating a pattern of strength alongside the dollar since July 2025; it continued to appreciate even against the backdrop of a dollar rebound. A rate hike does not necessarily imply a substantial strengthening of the dollar, and policy uncertainty in the US also exerts downward pressure. Domestic economic recovery in China may face some short-term headwinds, but the economy remains in the early stages of a non-typical "recovery."
A research report notes that the core logic currently driving dollar strength remains the "reflation trade." With US CPI persistently rising and the job market demonstrating resilience, the Fed's room for rate cuts has been significantly compressed, while expectations for marginal rate hikes have increased.
It is noteworthy that the magnitude of the yuan's depreciation in this round has been significantly smaller than the rise in the dollar index, highlighting the yuan's underlying resilience.
Analysis shows that since the beginning of the year, the yuan has appreciated against the dollar by approximately 2.7% even as the dollar index rose modestly by around 3%. Key supporting factors include a stabilizing external trade environment, a significant acceleration in China's export growth driven by the global AI investment boom, and limited economic impact from Middle East tensions. These factors have provided crucial support for the yuan exchange rate.
The analysis suggests the yuan is likely to remain in a relatively strong position in the near term. On one hand, the US-Iran memorandum and the gradual resumption of navigation in the Strait of Hormuz are conducive to easing inflationary pressures, which may reduce the Fed's urgency to hike rates and constrain the dollar's upward momentum. On the other hand, China's exports are expected to maintain relatively rapid growth. This implies the yuan has the potential to remain stable with a bias towards strength in the short term.
Seasonal Factors Behind Lower FX Settlement Ratio
Looking back at the first half of 2026 in the forex market, the US dollar index generally fluctuated within a range of 95.5 to 100.6. While the yuan appreciated overall during this period, the core drivers behind the appreciation varied across different stages.
From January to February, the yuan began a trend of appreciation, primarily fueled by the traditional seasonal wave of foreign exchange settlement. Analysis indicates that the net client settlement and sales position of banks was notably strong in January and February, with the settlement ratio remaining above 60%. Driven by this robust seasonal settlement, market expectations for yuan appreciation intensified, pushing the USD/CNY rate down rapidly from around 6.98 to near 6.83.
Entering the second quarter, progress in US-Iran peace talks and a moderation of Middle East geopolitical risks led to a phase of dollar weakness, further opening up space for yuan appreciation.
Analysis points out that while this round of yuan appreciation benefited from the weakening dollar environment, it was not merely a passive follower of a weaker dollar. In May, as the dollar index resumed its upward trend, the yuan did not depreciate significantly in tandem. Instead, it continued to appreciate against the dollar's movement, with stronger-than-expected domestic exports serving as a key pillar of support.
However, it is worth noting that the export settlement ratio dropped to 60% in April-May, down significantly from 68% in the first quarter and also below the seasonal average. This has raised market concerns that the apparent decline in the settlement ratio in April and May, indicating a weakening settlement wave and slowing export momentum, might signal the end of the current yuan appreciation trend.
Analysis suggests the lower settlement ratio may be influenced by seasonal factors. Looking at the scale of the net settlement surplus, it remains at historically high levels. In April and May, the yuan settlement ratio excluding forward contracts was recorded at 50.2% and 50.9% respectively, significantly lower than at the start of the year. However, on one hand, mainland companies listed in Hong Kong often conduct cash dividend payments in the second quarter, a seasonal behavior that may disturb the settlement ratio. On the other hand, high-frequency data shows that USD/CNY inquiry volume has stabilized marginally since June and remains at relatively high levels.
Analysis argues that a sustained decline in the settlement ratio does not necessarily mean the actual settlement volume has decreased. Bank settlement and sales data correspond to funds actually received and settled, which lags behind export declaration data by approximately 30-90 days. With export values hitting consecutive highs in April and May, the delayed release of settlement demand will continue to support the yuan exchange rate. Even if the settlement ratio has fallen, the actual settlement volume has not seen a sharp decline, serving as an important stabilizing force for the yuan in June.
Diverging Quarterly Trends Expected Within the Year
Comprehensive market analysis suggests that the core fundamentals supporting the yuan's medium-to-long-term strength remain unchanged. However, the market trend is expected to diverge significantly across different quarters within the year, with two-way fluctuations becoming the main theme of exchange rate movement.
Analysis indicates that under multiple external constraints, it will be difficult for the yuan to embark on a one-way appreciation path. Subsequent US tariff policies carry uncertainty, the drag on the global economy from Middle East conflicts will gradually materialize, and domestic export growth may face slowing pressure in the second half of the year. Simultaneously, the Fed is expected to continue its balance sheet reduction operations, requiring markets to continuously digest its relatively hawkish policy signals. The probability of a substantial decline in the dollar index within the year is low, with range-bound fluctuations being the more likely scenario. Against this backdrop, the yuan is expected to exhibit slight inverse fluctuations against the dollar, making a sustained one-way appreciation trend unlikely to reemerge.
Analysis points out that the pace of yuan appreciation may slow in the third quarter, with potential for phase-specific depreciation pressure. June to August is the traditional peak period for Hong Kong dividend-related forex purchases and profit repatriation by foreign enterprises. During this period, export-oriented companies might tend to wait for more favorable exchange rates to settle, leading to an overall weakening of settlement willingness and exerting some depreciation pressure on the yuan, making it "easier to fall than rise."
Nevertheless, multiple buffering forces will limit the yuan's depreciation space. From the perspective of corporate forex holding costs, analysis using the start of the 2022 yuan depreciation cycle as a baseline estimates that the current scale of accumulated foreign exchange awaiting settlement by enterprises is approximately $793.5 billion, with the cost for most companies concentrated in the 7.0-7.2 range. Once the USD/CNY rate approaches the key range of 6.90-7.0, corporate willingness to settle forex will increase significantly, offsetting the seasonal depreciation pressure from forex purchases.
The analysis also notes that it remains necessary to monitor the situation. If the pace of yuan appreciation in the fourth quarter becomes too rapid, reaching some critical levels, it cannot be ruled out that the central bank might once again deploy policy tools to break the market's consensus exchange rate expectations.
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