The Chinese yuan is widely expected to depreciate against an ascendant U.S. dollar. A thornier question confronting market watchers: Just how far and fast the currency could slide?

The stakes are huge. The impact of a pronounced weakness in the yuan could not only reverberate around the world by blunting export competitiveness for countries that compete with China to sell goods and services to the world but also imperil efforts by Chinese authorities to turbocharge growth in the world’s second-largest economy.

China’s offshore yuan has lost more than 3% since Donald Trump’s presidential election victory in early November as the outlook for monetary policy in the U.S. and China diverged. The tightly-controlled onshore yuan has also retreated to near a 16-month low.

Many investors are gloomy about China’s prospects. The country is grappling with a real-estate crisis and tepid consumer spending. With market participants worried about deflation and banks struggling to gin up demand for loans, there has been a flood of funds into government bonds, driving yields to record lows.

In contrast, policymakers at the U.S. Federal Reserve are now anticipating fewer rate cuts than they did previously. Higher tariffs proposed by incoming U.S. President Donald Trump, if materialized, could fuel inflation and slow down Federal Reserve’s easing cycle further, keeping interest rates, and consequently bond yields, elevated for longer.

The yield on the U.S. 10-year Treasury has been steadily rising since June and topped 4.7% this month, a level last seen in April. The U.S. dollar index, which measures the greenback versus six other currencies, has climbed to near a 26-month high.

Markets have pared expectations for the number of rate cuts by the U.S. Federal Reserves this year, pricing in only one quarter percentage cut in 2025, according to CME FedWatch tool as of Friday.

With the gap in yields between U.S. debt and its Chinese counterpart widening, investors have pushed up the dollar and dragged the yuan lower.

The market gyrations are testing the resolve of policymakers. While a weaker yuan should help improve the appeal of Chinese exports, authorities also want to avoid a sharp fall in the currency that could spark excessive volatility.

In a bid to lift bond yields, the People’s Bank of China suspended its government bond purchases last week, citing excess demand in the market, while ramping up bills issuance in Hong Kong to help stem yuan’s decline.

The central bank has lately ramped up announcements to warn against speculating against the currency and flagged that the bullish run in government bonds could undermine financial stability.

“We will resolutely prevent the risk of the exchange rate overshooting, ensuring that the yuan exchange rate remains generally stable at a reasonable, balanced level,” the PBOC Governor Pan Gongsheng said last week.

That echoed the sentiment at a separate press conference last Tuesday where senior officials reiterated the moderately loose monetary policy stance while stressing the importance of FX stability.

“Such communication implied the PBOC might prioritize FX stability over monetary policy easing in the near term,” Goldman Sachs economists said in a note last week.

The central bank on Monday kept benchmark loan prime rates unchanged as it strives to keep the currency stable.

Still, the offshore yuan could weaken to 8.5 per U.S. dollar by the year-end, said David Roche, a strategist at Quantum Strategy, factoring in a scenario of Trump imposing the promised 50%-60% tariffs on Chinese goods.

The currency last traded at 7.3357 against the greenback on Monday.

“Chinese authorities will try to make the yuan decline orderly,” Roche said, while cautioning that Beijing’s stimulus measures were “insufficient” to do more than stabilize the economy, as they have failed to tackle key issues such as sluggish demand and excessive household savings.

There are already signs that the fall in the yuan is limiting the ability of the central bank to lower rates. Preventing a steep fall in the currency has taken precedence over bolstering growth.

In rare forward-looking remarks, Gongsheng flagged in September the possibility of another cut in the amount of cash that banks need to hold as reserves by the end of 2024 — but the cut has not arrived, despite its shift to “moderately loose” policy stance.

The central bank is likely to refrain from cutting interest rate sharply in the near term, despite mounting pressure on domestic growth, said Helen Qiao, China and Asia economist at Bank of America, given the temporary policy priority on exchange rate stability.

She expected the central bank to continue defending the currency with tighter capital control and liquidity guidance to financial institutions.

While the hawkish Fed is limiting the room for PBOC to bring down interest rates, Beijing still has ample policy tools to prevent excessive currency moves, including verbal intervention, adjustment of offshore liquidity via bill issuance, and “enlisting state owned financial firms to directly buy CNH [offshore yuan],” said Lynn Song, chief China economist at LNG.

For the onshore market, a primary tool used by the PBOC to manage the currency has been the daily reference rate — the onshore yuan is allowed to trade only within a 2% range of this reference rate. Since last year, the central bank has been keeping the exchange rate guidance stronger than 7.20 per dollar, despite a surging greenback.

The onshore yuan was fixed at 7.1886 per dollar on Monday, but markets have been pushing it to the weaker side of the band, and it was last trading at 7.3249.

China’s economic activity accelerated more than expected in the final quarter of 2024, buoyed by robust exports as businesses front-loaded shipments ahead of tariff hikes, but experts warned that growth momentum might fade later this year as Trump’s tariff hikes come into play.

“Beijing does not want to see a collapse in the currency in advance of knowing what the situation is,” said Kamil Dimmich, portfolio manager at North of South Capital, alluding to uncertainty over the size and pace of tariff hikes from the Trump administration.

Trump, who will assume office on Monday, has pledged universal tariffs of 10% to 20% on all imported goods, and 60% or higher on shipments from China, although some believed the tariffs would be levied gradually.

“Although the tariff hike could be larger in trade war 2.0, the scope for the yuan depreciation may be much smaller this time,” said Larry Hu, chief China economist at Macquarie, given that Beijing has signaled its policy preference for a “relatively stable yuan.”

He projected the offshore yuan to peak at 7.50 per dollar in the third quarter this year.