MNI: Worries Over Yuan Overshoot May Trigger PBOC Intervention

--Weak Dollar Index and Big Dollar Sales Boost Stronger Yuan

--PBOC Could Step In As CFETS Index Rises

     BEIJING (MNI) - The People's Bank of China is expected to step in and curb

the sharp rally of the yuan over concerns that its strengthening is likely to

hurt exports and that expectations for further appreciation of the currency have

stimulated market speculators.

     Both the onshore and offshore yuan began the new year with a bang,

strengthening through the key level of 6.50 and approaching a three-month high

on the first trading day in 2018. The onshore yuan closed at 6.4960 against the

greenback on Tuesday afternoon, the strongest since Sept. 8, while the offshore

yuan touched as high as 6.4828.

     The Securities Times, an official economic journal run by the People's

Daily, stressed in a front-page commentary on Wednesday that the PBOC needs to

give the market some indication that it will stop the "over-expansion" of yuan

appreciation expectations and stabilize the forex market. 

     "The strongest force that pushed up the yuan on Tuesday was the emergence

of arbitrage transactions," a forex trader in Hong Kong told MNI. "In the past

week, the central parity price of the yuan was about 200 pips higher than the

overnight close on several days, which seduced some speculators into buying the

yuan when the U.S index was weak, and then selling off on the second day after a

much stronger fixing propped up the yuan during morning trade."

     The central parity price of the yuan has risen 1,242 pips over the past 11

trading days through Wednesday, with three of those days seeing a strengthening

of over 200 pips. The fixing on Wednesday was 6.4920, the strongest since May 3,

2017.

     Yuan appreciation expectations have been further cemented by the fact that

the currency strengthened 6.31% over the past year against the U.S. dollar,

compared with a 9.89% drop in the dollar index, which was the biggest fall since

2003.

     --FOREX SALES CLIMB

     A Beijing forex trader with one of the big state-owned banks told MNI that

enthusiasm for forex sales had been quite positive over recent days. "Our

clients, particularly import and export trade companies, are busy selling

dollars, which they have held in the past two years as the yuan has gotten

stronger," he said. "Many clients have asked for an increase in the prices of

forward forex swaps from a range of 6.55-6.60 to one of 6.50-6.56."

     "There is already a sign of the 'herd effect' in the market since market

participants are rushing to sell dollars, so the PBOC should not sit still for

too long," the trader said.

     The central bank introduced the "counter-cyclical factor" into its

formation of the daily central parity price at the end of May, when the yuan

first showed signs of rallying. The counter-cyclical factor theoretically lets

the central bank take greater control of the exchange rate setting, smoothing

out the impact of "irrational" investor sentiment.

     Li Liuyang, a forex analyst with China Merchants Bank, told MNI that the

PBOC's counter-cyclical factor could be triggered at any time when the yuan

index versus 24 trade-weighted currencies compiled by the China Foreign Exchange

Trading System sees a significant rise.

     "The CFETS index fluctuated in a range of 92 to 95.4 in 2017," Li said. "I

think the counter-cyclical factor or other action of the PBOC would work when

the index rises above 95 this year as the PBOC aims to maintain the stability of

the yuan against the currency basket," he added.

     The CFETS index rose to 94.85 last week, the highest since Nov. 10. In

2017, the yuan barely moved against the basket, appreciating just 0.02%,

according to MNI calculations.

     --HEADING OFF AN EXPORT DRAG

     As China is counting on exports as a main driver of economic growth this

year, a sharply appreciating currency is not an option for the government. Zhao

Yang, chief China economist at Nomura, predicted in an interview with MNI that

the pick-up in China's real effective exchange rate growth should be a drag on

exports, negatively impacting China's economic growth.

     Chinese government economists share that opinion. Zhu Baoliang, chief

economist at the State Information Center under the National Development and

Reform Commission, said during an economic forum late last month that China

should seize the opportunity presented by the global economic recovery and

devalue its currency while enhancing capital controls in order to guarantee

export growth.

     Looking forward, the yuan should see a period of adjustment after the most

recent round of appreciation, especially considering the low expectations for

further strengthening from both the PBOC and the market.

     According to HSBC, the current "fair value" of the yuan is around 6.60

against the U.S dollar. "It is the best choice for the yuan to maintain two-way

volatility around a reasonable level, considering the [government's] complex

targets of deleveraging and stable economic growth," the British multinational

bank said.

     The yuan closed at 6.5017 on Wednesday, a drop of 68 pips from the previous

close and stopping a three-day run of strengthening, and it weakened further on

Thursday after the PBOC set a weaker fixing level for the first time after five

consecutive trading sessions of stronger fixings. 

--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$]