Illustration: Chen Xia/GT

Recent appreciation of the yuan has sparked market discussion, particularly as the currency appears poised to break through the psychologically critical mark of 7 per US dollar for the first time since 2023.

The yuan's central parity rate strengthened 52 pips to 7.0471 against the US dollar on Wednesday, according to the China Foreign Exchange Trade System. It marks the currency's strongest level since September 30, 2024. The offshore yuan on Wednesday strengthened against the US dollar to break through the 7.01 mark, while the onshore yuan broke the 7.02 barrier, both gaining more than 1,000 basis points since late November and demonstrating a clear near-term strengthening trend.

In addition, according to Wind data, the offshore yuan has strengthened 4.4 percent against the dollar so far this year, while the onshore yuan has appreciated about 3.7 percent against the dollar.

These moves have taken place within a framework of an increasingly market-driven exchange rate mechanism, where enhanced flexibility and two-way fluctuations are the norm. The threshold of 7 yuan per dollar carries more psychological weight than economic substance.

An examination of the factors behind the recent yuan appreciation reveals a confluence of drivers. From an external perspective, the US Dollar Index has continued to fluctuate downward since falling below 100 in late November. Weakness in US economic data such as unemployment has reinforced market expectations for the Federal Reserve's interest rate cut trajectory, depressing the dollar and creating appreciation room for non-US currencies, including the yuan.

Domestically, China's economic fundamentals have shown sustained signs of stabilization and improvement as the year ends, with the financial market operating stably, thereby underpinning the relative strength of the yuan. 

The Central Economic Work Conference noted recently that the main goals and tasks for economic and social development in 2025 will be successfully accomplished. According to Li Bin, deputy director and spokesperson of the State Administration of Foreign Exchange, China's foreign trade and foreign investment remain resilient, cross-border capital flows and foreign exchange market expectations are stable, and foreign exchange transactions are being conducted in a steady and orderly manner.

The resilience and attractiveness of the Chinese economy provide solid fundamental support. Exports have demonstrated stronger-than-expected resilience, while the robust performance of China's capital markets continues to attract sustained inbound foreign investment. The scale of holdings of Chinese government bonds by international investors has been expanding. All these factors have provided support for the exchange rate in terms of capital flows.

However, it is crucial to recognize that a potential breakthrough of the 7.0 mark does not signal the start of a one-way appreciation path. Two-way volatility remains the expected norm, consistent with both market principles and policy intent.

Notably, the recently concluded Central Economic Work Conference noted that China will maintain the basic stability of the yuan's exchange rate at a reasonable and balanced level. The exchange rate policy is not a pursuit of a fixed rate but rather an emphasis on enhancing the flexibility and resilience of the currency. 

This policy approach helps avoid one-way expectations and sharp fluctuations that could affect the real economy, thereby fostering a stable monetary and financial environment conducive to sustained economic recovery.

Fundamentally speaking, the long-term trajectory of a major currency is ultimately anchored in the fundamentals and growth prospects of its economy. China is in a critical period of promoting high-quality development. The ongoing optimization of the economic structure, the increasing role of innovation-driven growth, and the steady advancement of higher-level openness jointly form the foundation for the stability of the yuan's value. 

A flexible and stable exchange rate helps the Chinese economy adapt more smoothly to changes in the external environment, cushions against external shocks, and creates a more suitable financial context for internal structural reforms and the shift in growth drivers. 

The increasing resilience of the economy will further solidify long-term market confidence in yuan-denominated assets, establishing a virtuous cycle where the exchange rate and economic fundamentals support each other.