MNI ANALYSIS: PBOC On Watch As Trade Hopes Sees Yuan Rally

--Investors Shorting Yuan Rush to Stop Loss on News of Easing Tensions 

--CNY at 6.25 Against USD May Be Key Test of PBOC Tolerance

     BEIJING (MNI) - The People's Bank of China may be on high alert following

the sharp yuan rise over the past two days, rallying on speculation that a trade

war with the U.S. may be averted.

     China wants the currency to be stable to help maintain economic stability;

a stronger yuan will further jeopardize exports already threatened by trade

conflicts.

     On Monday, the U.S. dollar had its biggest one-day fall against yuan in

nearly two months, losing about 500 pips from 6.31 to 6.26, meanwhile, against

the offshore yuan (CNH), the greenback dropped over 550 pips and closed at

6.2543, the lowest since Aug. 11, 2015, when China shocked global markets with a

2 percent one-off devaluation of its currency.

     The dollar plunged again against yuan Tuesday afternoon to as low as

6.2418, the weakest intraday price since Aug. 11, 2015 after PBOC fixed the yuan

central rate 377 pips higher at 6.2816 against the dollar on Tuesday morning,

the strongest since Aug.11, 2015.

     --PBOC TOLERANCE

     While the PBOC is more willing to allow the market a greater role in yuan

levels, it is nearing the end of its tolerance. Exports are likely to suffer

from the trade tussle with the U.S and further turbulence in the forex market is

the last thing policymakers wish to see.

     The recent sharp surge of the yuan has pushed the currency back to the

level before the 2015 devaluation, which may be the boundary of the PBOC's

comfort zone. For the onshore CNY market, 6.25 against the dollar would be a key

level to test the central bank's bottom line.

     A breach of this line of defence may prompt the PBOC to restart the

counter-cyclical factor, meaning direct market interventions. The central bank

may again ease controls over capital outflow, releasing some pent-up capital

eager to participate in the global markets.

     Moves have been taken by the authorities. For example, China has revived

the Qualified Domestic Limited Partnership (QDLP) quotas to foreign institutions

in Shanghai in a bid to encourage the outbound investment after stopping

issuance of that since an unofficial suspension in late 2015, when China

tightened capital controls amid turmoil in its stock and currency markets.

     --COMMODITIES MARKET DRIVER

     The market volatility was unexpected considering following the recent

period of yuan stability. The CFETS yuan index against the currency basket rose

only 0.43% so far from February and edged down 0.01% last week.

     The yuan's sharp rally started on Monday afternoon in the USD/CNH market,

triggered by a weaker dollar index following last week's marginally less hawkish

than expected rate outlook by the Federal Reserve. Market sentiment towards

shorting the yuan also began to reverse on news reports that China and the U.S.

are quietly seeking to resolve trade conflicts.

     CNY/USD then followed CNH and the thin volume of trading also easily

magnified the movement on Tuesday afternoon. CNH/USD rebounded after dropping

about 300 pips as forex purchase rose sharply from bank clients, including

China's big oil companies, which expected 6.24 to be a bottom.

     The launch of yuan-denominated oil contracts on Monday, which are expected

to increase international participation in China's commodity market and make the

yuan a more accepted currency in global markets, helping underpin the currency.

That, to some extent, helps explain why the yuan's big movement happened around

the same time as European oil markets began trading.

--MNI Beijing Bureau; +86 (10) 8532 5998; email: marissa.wang@marketnews.com

--MNI Beijing Bureau; +86 10 8532 5998; email: william.bi@mni-news.com

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

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