MNI: More Yuan Volatility Ahead, PBOC Vigilant

Weak sentiment, U.S dollar strength and the People’s Bank of China’s continued support for the yuan, unless other currencies extend their weakness, will keep volatility elevated and the central bank on guard over Q2, traders and advisors told MNI.

CNY unexpectedly broke 7.20 last Friday against USD, closing at 7.2292, its weakest 2024 level and its softest point since Nov 20, 2023, after over two months of sideways consolidation at the 7.10 level. Offshore yuan also swung 600pips, its most volatile move this year.

The fall indicated the currency had likely entered a new volatile trading phase from its previous “no pulse” period, a trader based in Shanghai told MNI, attributing the sharp decline to the strong dollar. The daily fixing was set at 7.1004 on Friday, the first time above 7.10 in two weeks, which also aroused concern among investors that the PBOC may tolerate a weaker yuan, he said. (See MNI Interview: Volatile Yuan Ahead As Uncertainty Dominates)

Depreciation pressure has accumulated in recent months as the central bank further eased policies, including reductions to the reserve requirement ratio and the loan prime rate, while officials also stressed publicly further RRR cuts were possible, he said. The gap between CNH and yuan fixing remained wide over February and March, which meant investors expected further easing, the trader added.

ROOM TO MOVE

The USDCNY ceiling may rise to between 7.24-7.26 over the short term, while USDCNH may approach 7.30, he predicted, noting the yuan will likely not touch 7.35 again, September's record weak point.

A Hong Kong forex trader said the USD index will dictate yuan performance, particularly if it breaks 105 and heads towards its 2023 107.35 high, alongside potential Bank of Japan action should the yen weaken to 152 against the greenback. The index traded at 104.19 on Tuesday.

Yuan depreciation pressure will increase this week but the stronger-than-expected daily fixing will moderate the pace, he said.

The PBOC’s daily trading band rule holds the yuan can only move within a 2% range higher or lower from the daily fixing, he explained, adding the weakest level the central bank can tolerate will be about 7.24 should the central bank set the fixing at 7.10.

The PBOC will also likely tighten CNH funding to raise the cost of shorting the yuan to curb weakness, he said, noting this occurred last Friday.

The PBOC has set the fixing back below 7.10 since Monday, beating market estimates. On Tuesday, authorities set it at 7.0943 against USD, 1076pips stronger than estimated.

POLICY RESPONSE

A policy advisor told MNI the strong dollar had weakened all major Asian currencies led by JPY. The PBOC may consider increasing the yuan’s flexibility should it judgethat CNY had been forced to appreciate against the basket currencies.

The China Foreign Exchange Trade System yuan basket index finished last week at 99.3, compared with its highest level at 99.4 this year after the currency rose to its strongest level since 1992 against the yen.

As the Chinese economy recovers, a flexible and stable exchange rate – particularly against trade partner currencies – is important and realistic, the advisor said. A range of positive factors is supporting the yuan, including the recent capital inflow into domestic financial markets, he continued.(See MNI INTERVIEW2: CNY Strengthens, Third Plenum To Detail Reform)

Chinese interest rates are low, which has driven the spread between China and the U.S to a wide level, he added, noting the PBOC would not adjust its policy rate unless credit expansion stalled in Q2.

The PBOC’s stance of ensuring the yuan exchange rate remained stable had not changed and 7.3 is still a supportive level for 2024, he predicted.