MNI ANALYSIS: Tacit PBOC Consent Backing China Yuan Rise

--Yuan Rise Expected to Continue, At Least In Short-Term

--Speculation that 6.5 to USD Is Limit of PBOC Tolerance

     BEIJING (MNI) - The yuan's strong appreciation momentum looks set to

continue as depreciation expectations have gradually dissipated amid an extended

surge in the Chinese currency against the U.S dollar, fueled by the tacit

acceptance of the rise by the People's Bank of China.

     Some market participants are speculating that a dollar-yuan exchange rate

around 6.5 -- which would represent about a 6% appreciation for this year -- is

the limit of the PBOC's tolerance. However, the yuan is increasingly expected to

continue rising in the short run. 

     The onshore yuan exchange rate jumped 1.96% against the dollar in August,

the largest monthly appreciation since July 2005 -- the month China ended the

yuan's peg against the U.S. dollar. On July 21, the day of the de-pegging, China

strengthened the exchange rate 2.1% to 8.1100 from 8.2765.

     Last week, the yuan exchange rate attracted global attention as it surged

1.45%, the biggest weekly rise on record, according to data going back to the

month of the de-pegging. It was a sure sign that yuan depreciation expectations

had come to an end.  

     Meanwhile, the daily central parity rate, a benchmark showing the PBOC's

stance on the yuan exchange rate, rose 1.01% last week, also a weekly record. As

of Wednesday, the fixing has increased eight straight trading days, the longest

consecutive period of rises since October 2015, which indicates that the recent

pace of the rise has been within the regulator's tolerance zone -- and possibly

that a further rise is still in its comfort zone. 

     The "counter-cyclical adjustment factor," introduced by the PBOC into its

daily fixing calculation in May, could have been used to slow or even stop the

yuan rise but has instead helped to boost this round of yuan strengthening. 

     Cheng Shi, chief economist at Industrial and Commercial Bank of China

International (ICBC), said in a recent note that by using the counter-cyclical

adjustment factor the PBOC has managed expectations so that the yuan exchange

rate rose by 61.9 pips against the greenback in June and July, nearly double the

35.5 pip gain in April and May.

     Sheng Songcheng, an adviser to the PBOC and its former statistics chief,

said Friday at a financial forum sponsored by Tsinghua University that there was

"no basis for long-term yuan depreciation" now, considering China's economic

fundamentals and financial situation.

     Sheng had previously stated that it was "completely possible" for the yuan

to rise to as high as 6.5 against the U.S dollar this year.

     The stance of the PBOC has encouraged market participants to accelerate

foreign-exchange sales, as they estimate the yuan will continue its strong

momentum, particularly with the U.S dollar in a weakened position.

     "The strong trend will continue since market expectations have largely

turned toward yuan appreciation," a Shanghai forex trader with a large

joint-stock bank told MNI. "Our clients, particularly those who previously went

long on the dollar, are anxious and are tending to sell dollars, even closing

their positions to stop losses," he said. "As a market maker, we have piled into

the yuan when it has risen to some key levels, like around 6.52, even if it

could strengthen further to 6.5 if the U.S. dollar continues to drop and the

'herd effect' of foreign-exchange sales increases," he said. 

     Surging carry costs for shorting the yuan may trigger unwinding of the

hefty "de-facto" short yuan positions accumulated since 2014, especially those

held by the Chinese corporate sector, Liang Hong, chief analyst with China

International Capital Corporation, said in a note on Monday. "Our estimate

suggests that outstanding unsettled exporter FX proceeds stand at $300 billion

to $600 billion. Furthermore, the carry trade unwind will likely develop into a

self-reinforcing process," Liang predicted.

     The heavy and continued sales of foreign currencies mainly contributed to

the yuan's jump last week. Even though the U.S dollar index actually rose 0.34%,

floating in a range of 92 to 94, the yuan continued to show rising momentum.

This means the long-expected yuan appreciation expectations have started to take

hold. 

     On Aug. 11, 2015, China suddenly and dramatically devalued its currency by

nearly 2% against the greenback, the largest devaluation in a decade -- a

surprise policy change that roiled international currency markets. Since then,

the yuan has been floating in a range of 6.3 to 7.0 against the dollar.   

     "The strong performance of the yuan is in line with the PBOC's intention,

and exchange-rate reform also targets a wider range of the daily yuan

fluctuation," Li Liuyang, a forex analyst with China Merchants Bank, the

sixth-biggest commercial bank in China, told MNI. "Demand for the yuan will

continue to increase, considering investors who have been betting long on the

dollar have not been cleared out yet, so the yuan will appreciate further, at

least this year," he said.

     Some at the PBOC have recently floated the idea of widening the yuan's

daily trading range against the U.S. dollar to allow for greater two-way

volatility. Wang Yu, the vice director of the PBOC's Research Bureau, said at a

forum in June that authorities should expand the trading range to accelerate

market-oriented reforms of the exchange rate.

     The last time China expanded the yuan's allowable daily trading range

against the U.S. dollar was on March 15, 2014, when it broadened the range to 2%

above and below the daily parity set by the PBOC, from the previous 1%.

     As the yuan continues its strong and stable orbit, capital outflows -- the

bane of government authorities over the past two years -- have reversed. As a

result, China may loosen some of the capital control measures it has implemented

since late 2015, especially those seen as having been ad-hoc in nature. "A

reasonable starting point may be to loosen the controls over household sector

foreign-exchange usage," said Liang, the CICC analyst.  

     However, the yuan's sharp rebound over the past few weeks is expected to

abate, although upward momentum should continue. 

     "I expect that yuan appreciation will peak at around 6% and get supported

at about 6.5 against the U.S. dollar this year, since each main-weighted

currency [versus the U.S. dollar] except the euro has risen by around 6%," a

Beijing trader with one of the big four state-owned banks told MNI. "But the

precondition is that the U.S. dollar remains stable. A big jump against the

(official trade-weighted) basket of currencies would violate the PBOC's aim of

maintaining the overall stability of the yuan exchange rate."

     So far, the yuan have appreciated 5.94% this year against the U.S. dollar,

compared with a 7.02% depreciation last year.  

     As the U.S dollar index is seemingly approaching its bottom, assuming

passage of a U.S. tax-reform plan before mid-term Congressional elections occur

late next year, the yuan could come under renewed downturn pressure. But unless

the dollar makes a strong recovery, the current momentum of the yuan should be

maintained, at least in the short-term.

     "In the current situation, if the Trump government could make big efforts

that would pop the dollar index back up to 100, maybe the yuan would see a

depreciation trend. But if the index just fluctuates around 94, we do not think

the [yuan's appreciation] momentum will be reversed," the Beijing trader said.  

     On Tuesday, the U.S. dollar index closed at 92.3, down 0.35% for the day. 

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

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

--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

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