MNI ANALYSIS: Yuan Finds Footing On Weak Dollar, Firm Controls

     BEIJING (MNI) - The yuan exchange rate has managed to maintain its strong

momentum against the greenback as the U.S. dollar index keeps plunging and

Chinese government controls over capital flows remain tight.  

     The onshore yuan saw a big rise on Tuesday, breaking the key level of 6.7

against the U.S. dollar at noon, jumping to as strong as 6.6963, the highest

since Oct. 10, when it hit 6.6904. It closed at 6.7035 on Tuesday, the strongest

closing rate since the 6.7028 close on Oct. 10.

     The offshore yuan jumped 0.32% to 6.7196 against the U.S. dollar at 5pm

Beijing time, with a high of 6.7019 for the day, which was also the strongest

since Oct. 10, when it reached 6.7013.

     "The level of 6.7 is a fairly important threshold that most investors are

concerned about," a Beijing trader with one of the big four state-owned banks

told MNI. "As long as the yuan exchange rate breaks the level, the market

sentiment for yuan appreciation would be more active, and depreciation

expectations would reverse."

     The weak U.S. dollar index has been the main contributor of this round of

yuan appreciation. The index has continued to fall after it peaked at 103.8 in

January and subsequently broke 93 on July 28. It was last at 93.3044 on Tuesday.

So far this year, the dollar index has plunged 8.88%, compared with a 3.73% rise

in 2016.

     Guo Jiayi, forex analyst at Industrial Bank, told MNI that market sentiment

for the U.S. dollar is negative, which has boosted the yuan exchange rate. "Yuan

appreciation will continue as the U.S. dollar is expected to get weaker ... in

the second half of this year," she said.

     Intervention in the forex market by the People's Bank of China, coupled

with strict capital controls, have also had a significant effect.

     "The appreciation of the yuan is mainly because of the counter-cyclical

factor," a Shanghai-based FX trader said. "The new yuan fixing model is

hindering yuan depreciation."

     The PBOC added a counter-cyclical factor to its fixing model around May 26,

which granted the regulator more power to "guide" exchange-rate fluctuations,

particularly when the yuan exchange rate weakens compared with the daily fixing.

     The PBOC set the yuan central parity rate against the U.S. dollar at 6.7184

on Tuesday, stronger than Monday's 6.7228. Since May 26, the yuan fixing has

been adjusted higher by 2.2%. The yuan exchange rate against the U.S dollar has

risen 2.3%.

     Controls on capital flows have also had their intended effect, with

individuals' foreign-exchange purchases and companies' outbound direct

investments both shrinking in the first half of this year. According to the

Ministry of Commerce, ODI fell 42.9% year-on-year in the first six months, which

it attributed to "irrational investments" being curbed.  

     Meanwhile, foreign financial institutions are increasing their holdings of

yuan assets, which can be seen in increased capital inflows.

     As a result, China's foreign-exchange reserves rose in July for the sixth

month in a row, increasing $23.93 billion to $3.0807 trillion, the highest level

since October 2016.

     The pressure on the PBOC to maintain the stability of the yuan exchange

rate, therefore,  has been reduced at present -- so long as the yuan maintains

its strength.

     "I don't see that the PBOC will jump in to sell yuan to intervene in the

market," the Shanghai trader said, adding that most traders agree the PBOC is

happy that the yuan has shown upward momentum this year after nearly two years

of constant depreciation expectations.

     In addition, the unexpectedly strong performance of the Chinese economy in

the first two quarters of the year has also supported yuan gains. GDP growth in

the first half of year was 6.9%.

     Guo with Industrial Bank said that "unless the economy sees a sharp

slowdown, the yuan's strong momentum should not reverse, and I do not think

there will be a big downturn this year."

     Many financial institutions have raised their forecasts for the yuan

exchange rate accordingly. Merrill Lynch changed its forecast to 6.70, from the

previous 6.95, for this quarter, while it expects the yuan to be at 6.9 at the

end of the year, compared with its previous expectation of 7.05. 

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

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

[TOPICS: M$A$$$,M$Q$$$,MT$$$$,M$$FX$]