By Saumya Vaishampayan and Chelsey Dulaney
The Chinese yuan rallied against the dollar on Thursday, but investors remain on edge as the country's central bank continues to allow the yuan to weaken amid an intensifying trade fight with the U.S.
The Chinese currency rose 0.6% against the dollar in offshore markets during Thursday's U.S. trading session, extending a rebound that began in Asian trade. That came after the People's Bank of China guided the yuan down by 0.7% at its daily fixing, the largest-one day decline in 18 months.
Onshore, where the currency is allowed to trade as much as 2% above or below the daily fix, the yuan ended little changed against the dollar.
Despite Thursday's reprieve, investors are still on edge over the yuan's rapid descent over the past month, which has spurred fears that China is using a weakened currency as a form of retaliation against the U.S.'s trade threats.
The yuan has now declined more than 2% against the dollar in 2018, retracing gains made early in the year. It has also reversed its annual advance against a basket of currencies weighted by trade volumes, according to a gauge published by Wind Info.
A weaker currency would make China's exports cheaper and could help cushion the impact of U.S. tariffs on China's economy, which has already been slowing. On Tuesday, the U.S. said it would impose 10% tariffs on $200 billion in Chinese products, less than a week after the countries slapped tariffs on $34 billion in each other's goods.
Still, a currency depreciation would be a risky move for China. In 2015, an unexpected devaluation in China's currency sparked capital flight as Chinese companies, citizens and investors sought to escape further declines. Allowing the yuan to weaken too fast could revive those outflows, adding further downward pressure on the currency that economists warn could become difficult for Beijing to manage.
Volatility in China's markets has also proven destabilizing to global markets in recent years because of the country's outsize role in the global economy. Many U.S. companies have large businesses in China, and weakening growth there has sometimes weighed on revenues of companies like Caterpillar Inc.
China also is one of the largest users of commodities such as coal and iron ore; softer demand for those products has rattled both those markets and the economies of the countries that export them.
So far, analysts see few signs that China is aiming for a currency devaluation.
In addition to the trade-related worries that have driven investors to dump the yuan, monetary policy is also weighing the currency down. While China's central bank could cut interest rates or free up banks to lend more in the coming months, the U.S. is set to keep raising rates.
"This is very different from 2015, when it was the PBOC who initiated the move," said Eddie Cheung, Asia currency strategist at Standard Chartered Bank, referring to a previous devaluation.
"This time around, it's driven by the market," Mr. Cheung said. "The PBOC has been leaning against all of this."
Write to Saumya Vaishampayan at firstname.lastname@example.org and Chelsey Dulaney at Chelsey.Dulaney@wsj.com