Liquidity Squeeze Bolsters Yuan, USD/CNH Approaches Session Lows

Spot USD/CNH has unwound its earlier gains after hitting resistance around the 7.3360 mark, with the overnight session headlined by the surprisingly conservative Loan Prime Rate (LPR) fixing. The pair is now back to virtually unchanged levels, last sitting at 7.3062.

• The market was caught off guard as the PBOC kept the 5-Year LPR unchanged at 4.20% (versus 4.05% expected) and trimmed the 1-Year LPR by 10bp to 3.45% (versus 3.40% expected). 5-Year LPR is the benchmark rate for most mortgages in China, while 1-year LPR is used as a reference for most household and corporate loans. The failure to meet market expectations comes after signals anticipating more forceful stimulus for the flagging economy, including last Friday's meeting in which the PBOC asked local lenders to boost loans.
• Another stronger than expected USD/CNY mid-point fixing (880-pip bias versus BBG estimate) did little to shield the redback during local hours, with the conservative LPR fixing sowing confusion. The PBOC effectively signalled reluctance to support credit markets despite the ongoing turmoil.
• Offshore yuan has recouped most overnight losses amid a liquidity squeeze, with forward points rallying into the European morning. Bloomberg cited trader sources as attributing this to "a combination of less CNH supply from big Chinese names in offshore yuan swap market since last week, and liquidity demand derived from PBOC's bill sales tomorrow." They also pointed to "borrowing demand from some market players (...) after 3pm local time (...) aside from dollar sales by the overseas branches of Chinese banks."
• CNH 3-month forward points have surged to best levels since February; 12-month forward points are at best levels since May.