MNI: PBOC To Allow Yuan To Drift Lower-Advisors And Traders

The People’s Bank of China is set to oversee a gradual depreciation of the yuan amid persistent U.S dollar strength, policy advisors and traders told MNI, though they pointed to probable strong support at the 2023 low of 7.35 to the greenback.

The yuan has depreciated only about 2% against the U.S. currency this year, while the dollar index has risen by almost 5%, holding below 7.28 largely thanks to the PBOC’s stronger-than-expected daily fixings and offshore dollar sales by big state banks.

But this stability together with persistently high interest-rate differentials has only encouraged traders to bet on depreciation, which will eventually compel the PBOC to allow a broader range of volatility within its managed exchange rate system, an advisor familiar with the matter told MNI, adding that yuan weakening was likely to remain a long-run trend given U.S. economic fundamentals and the dollar’s safe-haven status.

While the central bank will not defend particular levels, it will push back against sudden sharp moves, the advisor said, noting how the PBOC sent a strong signal by issued additional offshore yuan-denominated central bank bills this year to tighten offshore liquidity.

Governor Pan Gongsheng promised in June to maintain exchange rate flexibility, but “resolutely guard against the risk of the yuan exchange rate overshooting.” (See MNI EM: China Yuan Seen Breaching 7.3, Strengthening Against Basket)

A-SHARE OUTFLOWS

The yuan will continue under pressure in July as foreign-listed companies buy currencies for mid-year dividend distributions and as declining risk appetite prompts outflows from A-shares, a Shanghai trader said. Exporters are also keen to hold dollars, the trader added, while 7.35 would be the next support should USDCNY break 7.30 in the short term.

The offshore USDCNH rate passed 7.30 on June 28, as the dollar index rallied over 106, and onshore USDCNY slid past 7.27 on July 2, both levels the weakest in seven months.

The central bank’s tolerance for orderly depreciation has increased, a Hong Kong trader told MNI, pointing to seven consecutive weaker fixings since June 19, the longest stretch for a year. Still, the gap with market estimates remains slightly below 1,500 pips, while state-owned banks have continued to sell dollars in offshore market whenever CNH has sold off sharply. CNY daily trading has come close to the 2% limit from fixing since mid-June, storing up further depreciation pressures, the trader said.

Interest rate differentials and rigid currency management are further fuelling carry trades, former State Administration of Foreign Exchange senior official Miao Yanliang said recently in a public note, adding that the regulator should seize upon any temporary retreat by the dollar and U.S rates to push the traded yuan price closer to fixings. A temporary burst of volatility could alter market expectations, he said.

The advisor said the central bank is unlikely to make deliberate moves to devalue given that robust exports and concerning capital outflows from A-shares. Up to CNY44.45 billion left A-shares in June, the highest this year.

With western countries complaining of Chinese overcapacity, sending the yuan lower would be impolitic, he said.

INTEREST ON DOLLARS

The dollar will continue to be the biggest driver of yuan weakness, the Shanghai trader said, predicting the Chinese currency could fall by 2-2.5% should the dollar index gain another 5%. Domestic fundamentals are not supportive either, he continued, pointing to disappointing Q2 data, lasting property sector weakness and policy stimulus which fell short of expectations. (See MNI EM INTERVIEW 2: China Fiscal Expansion Crucial, RRR Cut Eyed)

An exporter from China’s east coast told MNI local banks offer more than 6% interest on dollar deposits, and that with the yuan’s outlook weaker at least for the third quarter, it makes sense to hold U.S. currency for now.

SAFE data showed banks’ foreign exchange purchases on behalf of clients totalled 68.6% of clients’ foreign exchange expenditures in May, while sales were equivalent to only 60.6% of their foreign currency income, the eleventh consecutive month that purchases outpaced sales.

But, while the yuan faces difficulties ahead, it could bounce, with a chance of retreading to 7.20 or even 7.1 if the dollar index makes a technical retreat from 106, the Hong Kong trader said.

Official moves to support markets are likely ahead of the Chinese Communist Party’s Third Plenary Session from July 15 to 18, which could also see reform announcements, the advisor noted, adding that the yuan usually strengthens in the last quarter of a year, as the average yearly exchange rate is used for annual GDP calculations.