MNI SOURCES: More PBOC Tolerance For Strong Yuan Amid Rebound

The People's Bank of China is becoming more tolerant of a strong yuan, as the country's economy recovers more strongly than its major competitors from the pandemic hit earlier in the year and as Beijing abides by the currency stipulations of the Phase One trade deal with the U.S. despite bilateral tensions, policy advisors and foreign exchange strategists told MNI.

But any excessive rally is still likely to be met with intervention, as the PBOC will want to ensure the currency remains a two-way bet, they said, adding that this could mean it trades within a wide band, perhaps from 6.5-7.2 during 2020. It would take a big drop in the dollar index to drive the yuan below 6.5, they said, while any resurgence of tensions with the U.S. or major uncertainty following next month's U.S. presidential elections could still drag it back above 7.

The yuan gained 971 pips or 1.43% on Friday as trading resumed after a week-long national holiday, its biggest one-day rise since July 2005 and taking it to as strong as 6.6929 against the dollar, a 6% appreciation since the end of May. But the currency eased, fixing at 6.7473 on Wednesday, following the PBOC's announcement on Saturday that it would remove the reserve requirement applied to FX forwards transactions, effectively making it cheaper to short-sell the yuan.

"It has impacted market sentiment, but it was not a strong warning," a policy advisor said, noting the PBOC is still reluctant to weigh on the currency via setting a sharply weaker daily fixing. The yuan should regain its poise as the impact of the move fades in the short term, he said.

The removal of the reserve requirement, which had been reinstated in August 2018 when trade tensions put downward pressure on yuan, restored a more neutral setting to the forex market, the advisor said.

ECONOMIC STRENGTH

Nonetheless, despite the move, the stronger-than-expected midpoint in Friday's daily fixing, 109 pips firmer than Reuters' estimate, indicated that the PBOC was in no rush to curb the yuan's appreciation, said an FX analyst at a state-owned bank. The fixing has been set slightly weaker so far this week.

The PBOC's tolerance for the rally reflects its recognition of the economy's renewed strength and of the wide interest spread between China and the U.S., the advisor said, noting that an appreciating currency helps to attract foreign investors. The yield spread between the 10-year U.S. Treasury and equivalent Chinese government bonds, currently 240 bps, had contributed about 2% to the yuan's strength so far this year, he said. The Phase One trade deal with the U.S. also committed China to not seek to lower the value of its currency for competitive reasons, the advisor noted.

The Chinese currency has seen sustained strength since talks with the U.S. on Aug. 25, a second advisor observed. The CFETS RMB Index, which gauges the yuan against a basket of currencies from 24 major trading partners, rose to 94.40 on Sept. 30 from 91.42 on July 31. A range of 91-96 for the index should be comfortable for the central bank, the advisor said, predicting that it would remain below 95 this month.

So far, the yuan's appreciation has not been accompanied by undue upwards pressure on asset prices, with controls on the property market in particular, so the PBOC will see no urgency in taking moves to curb capital inflows, the second advisor said