MNI: Signs Of PBOC Counter-Cyclical Factor In CNY Fix-Analysts

The People’s Bank of China may already have started requiring banks to incorporate the so-called “counter-cyclical factor” into their yuan-fixing models, and is likely to take more measures to cool one-way market bets on a sharp weakening in the currency without attempting to reverse the recent depreciation trend, FX analysts and traders said. (See MNI MARKET ANALYSIS: Yuan Defence Steps Up)

The counter-cyclical factor, whose details are not public, may explain the stronger-than-expected fixings of the past six days, said analysts at China International Capital Corporation. It would be the first use of the factor since October 2020, when the PBOC’s foreign exchange system said the 14 banks participating in daily operations to set the CNY mid-point had removed it from their calculations.

As of 4 pm Wednesday Beijing time, the yuan had dropped 0.4% against the greenback so far this week, the worst performer among G10 currencies after Federal Reserve Chair Jerome Powell signalled his determination to keep raising rates to curb inflation on Friday. The CFETS RMB index fell to 101.92 as of the end of last week, compared with the peak at 106.79 in March.

The onshore CNY rate declined 500 pips on Monday, breaking three support levels in one day, at 6.90, 6.91 and 6.92 to the dollar, while the offshore CNH measure dropped to 6.93.

The increasing gap between CNY and CNH raised concerns over increasing short-selling of the yuan, and the PBOC set Tuesday’s CNY fixing at 6.8802, much stronger than the expected 6.9051.

SLOWER EXPORT GROWTH

The yuan may weaken for the rest of the year as the dollar strengthens and Chinese export growth is likely to slow, said Bank of China International chief economist Xu Gao, predicting the PBOC would avoid direct intervention so long as changes in the exchange rate remain orderly.

The rate is likely to fall through 7 to the dollar, traders said, meaning that it would have fluctuated by more than 10% this year. So far in 2022, the yuan fixing has fluctuated by 9.19%, with CNY moving by 9.58% and CNH 9.51%.

Recent PBOC rate cuts show officials are willing to increase the flexibility of the exchange rate to cushion the effects of a tougher external environment, and it may limit the speed of depreciation at certain key levels but is unlikely to try to reverse the market’s direction, said Zhang Yu, chief economist at Huachuang Securities.

A challenge for the authorities may come later in September, as the Fed accelerates quantitative tightening, potentially adding to dollar strength, said Yin Yi, analyst at Guohai Securities, predicting that the PBOC may require banks to set aside more cash when purchasing currency forwards, or reduce banks’ FX reserve ratios, which would unlock dollar liquidity, as well as applying brakes through yuan fixing as the 7 level draws near.

Even as it grapples with yuan weakness, the PBOC’s priority must remain supporting the domestic economy, particularly via credit expansion, analysts said.

China needs further rate cuts or more fiscal stimulus, which will eventually support the yuan by boosting economic fundamentals, said Zhang Bin, senior fellow at the Chinese Academy of Social Sciences, noting that demand for the currency is correlated with the performance of purchasing managers’ indices (PMI).