RPT-MNI: PBOC Reduces Yuan Support, Wide Volatility Band Ahead

(Story first published Aug 28)

MNI (BEIJING) - The People’s Bank of China has likely suspended the counter-cyclical factor within its daily fixing formula following the yuan’s rise to its strongest level against the U.S dollar this year, traders and advisors told MNI, noting a wider trading band was likely throughout the remainder of 2024 with USDCNY potentially breaking the 7.10 handle. 

The gap between the PBOC’s official yuan fixing and market estimates, which narrowed to 85pips on Aug 14 – its first time below 100pips since June 2023 – suggested the Bank may have temporarily ceased using the counter-cyclical factor, market participants told MNI, an indication the central bank had reduced its support for the currency.

The Bank also set the fixing at 7.1307 on Aug 21, weaker than the 7.1300 estimate, the first time this has occurred in over a year, according to MNI’s calculations, potentially indicating a change to the PBOC’s FX stance. The central bank has consistently set a stronger-than-expected fixing to guide spot prices and curb the yuan’s depreciation pace over the past year. 

The PBOC also conducted an equal rollover of offshore central bank bills last week, rather than drain CNH liquidity, a further signal it had relaxed control, a trader based in Shanghai told MNI, noting USDCNY had fallen to 7.11 on Monday, its lowest level since January. The yuan would likely swing in the 7.10-7.20 range against the dollar in the short term, the trader predicted.  

The pair fell to 7.1 from 7.2 over August thanks to the unwind of the carry trade and the decline of the dollar index to a one-year low on weak U.S. employment data and Federal Reserve signaling of a September rate cut. (See MNI INTERVIEW: China Yuan To Find Support in H2)

An advisor familiar with forex policy operations told MNI FX market expectations have started to stabilise as the PBOC’s fixing, the onshore and offshore yuan aligned. 

The central bank's decision to dump the counter-cyclical factor, which will add flexibility to the exchange rate, may also signal its unwillingness for significant yuan strength to disrupt FX market balance, he said, predicting the currency's fixing would remain around 7.10 in September. (See MNI: PBOC Seen Capping Yuan Fixing At 7.10 After Rally ) 

However, more flexibility will lead to greater intraday volatility, he added, arguing the PBOC will reinstitute the factor if necessary. China’s weak economy cannot support a fast rise of the currency and the dollar could appreciate, while the U.S election in November presented uncertainty, he continued. 

DOLLAR SETTLEMENT 

But increased dollar settlement could drive the yuan to appreciate rapidly in the short term, a trader in Hong Kong told MNI, potentially pushing the yuan to strengthen quickly toward about 7.0.

Chinese import-export companies have accumulated significant dollar positions and their demand for the yuan has remained strong since July. According to the China Foreign Exchange Trade System, yuan trading volume surged to USD63.7 billon on Aug 5, the second highest in history after the USD66.3 billion recorded on Oct 24, 2018.

If yuan trading volume further spikes above USD50 billion in a single day, it could exert pressure on the current onshore FX market, the trader added, noting significant settlement demand had been seen at the 7.12 level. 

The advisor doubted USDCNY would reach 7.0 in the short term as any sharp move higher would trigger the PBOC to act. 

CURRENCY BASKET

The yuan has underperformed other currencies against a weak dollar, with the CFETS basket falling to its weakest level this year at 97.89 last Friday. 

The advisor noted exports had slowed and the threat of a new round of tariffs next year coupled with the continued weak domestic economy had likely driven the yuan’s poor performance against the basket, while the yuan's upward turning point against the dollar remained unconfirmed.