July 4,2010
Yuan may fall as volatility picks up
* Likely to rise medium term, but no straight line
SHANGHAI: Now that China is staying true to its word and letting the yuan trade a bit more freely, analysts and investors outside the mainland may not be prepared for one potential outcome: a yuan drop.
China is showing a determination to let the yuan be more volatile against the dollar within its daily 0.5 percent trading band and go with the market flow, contrary to some expectations for another steady rise as happened between 2005 and 2008.
That means there are no guarantees that the yuan will appreciate against the dollar over time, and Beijing is set to stick firmly to its position on yuan flexibility no matter how much it disappoints critics — most prominently US lawmakers. The fundamentals arguing for substantial yuan appreciation have changed since the financial crisis: China is running smaller trade surpluses, and economists see the potential for the shrinking current account surpluses to turn into deficits in coming years.
As a result, the basis for steady but slow yuan appreciation versus the dollar is not as strong as five years ago — one reason why Beijing keeps emphasising flexibility in its pushing forward the reform of its currency system. The People’s Bank of China (PBoC) has matched its words with deeds by allowing greater yuan volatility since the June 19 announcement and subsequent clarification that flexibility still means that yuan moves must be gradual and controllable.
The yuan has moved in an average daily range of more than 100 pips since its depegging, far above the 50 pips that dealers say would allow banks to engage in proprietary trading intraday. This compared with a daily movement of only a few pips during the two years when the currency was pegged to the dollar. Banks are just starting to do more day-to-day speculation, adding to liquidity in the local spot market. Before the depegging, the limited daily swings meant all trading was almost a pure reflection of supply and demand, with the PBoC keeping the market in check.
Realised volatility in dollar/yuan has jumped as spot has started swinging more sharply within the daily trading band on the official CFETS platform.
Watch the state-owned banks: The PBoC is apparently fostering two-way trade within the daily trading band for the spot yuan rate, trying to get banks and companies accustomed to greater volatility and to hedging currency risks.
But during the peak of speculation on yuan gains early last week, the PBoC used state banks to buy dollars in hefty chunks, effectively limiting the market’s ability to short dollar/yuan — especially since banks are not allowed to hold short positions overnight. Dealers said the state banks scooped up dollars at a wide variety of levels, suggesting the authorities were not trying to defend the yuan at a certain level.
These mechanisms are a step back from direct intervention by the PBoC in trading, often employed in the post-revaluation phase of yuan appreciation from 2005 to 2008 and during the de facto dollar peg of the past two years. Dealers also believe the PBoC may have also adopted a new formula for setting the mid-point, or its reference rate, for the daily trading band.
It appears it sets the mid-point using the yuan’s close on the previous day plus overnight moves in the dollar index, making the mid-point market-oriented rather than an expression of the central bank’s desires as before. But traders expect the PBoC to keep the mid-point as a ready weapon for the PBoC for limiting any yuan moves during times of market volatility. The PBoC consults with banks but keeps the market in the dark as to how it sets the rate.
During the peg, the PBoC tweaked the mid-point by only one or two pips each day. Any trades happened far from the reference rate on a given day would have to be covered around the mid-point in subsequent days, discouraging moves far from the mid-point.
Since the depegging, the yuan has risen as much as 0.83 percent as the PBoC tolerated a rise to a post-revaluation high of 6.7700 against the dollar on Friday. While the new regime has still disappointed critics in the United States, Chinese market players believe that Beijing will not make any further concessions and that new pressure from US lawmakers — some of whom believe the yuan is undervalued by as much as 40 percent — would likely backfire. reuters
Yuan may fall as volatility picks up
* Likely to rise medium term, but no straight line
SHANGHAI: Now that China is staying true to its word and letting the yuan trade a bit more freely, analysts and investors outside the mainland may not be prepared for one potential outcome: a yuan drop.
China is showing a determination to let the yuan be more volatile against the dollar within its daily 0.5 percent trading band and go with the market flow, contrary to some expectations for another steady rise as happened between 2005 and 2008.
That means there are no guarantees that the yuan will appreciate against the dollar over time, and Beijing is set to stick firmly to its position on yuan flexibility no matter how much it disappoints critics — most prominently US lawmakers. The fundamentals arguing for substantial yuan appreciation have changed since the financial crisis: China is running smaller trade surpluses, and economists see the potential for the shrinking current account surpluses to turn into deficits in coming years.
As a result, the basis for steady but slow yuan appreciation versus the dollar is not as strong as five years ago — one reason why Beijing keeps emphasising flexibility in its pushing forward the reform of its currency system. The People’s Bank of China (PBoC) has matched its words with deeds by allowing greater yuan volatility since the June 19 announcement and subsequent clarification that flexibility still means that yuan moves must be gradual and controllable.
The yuan has moved in an average daily range of more than 100 pips since its depegging, far above the 50 pips that dealers say would allow banks to engage in proprietary trading intraday. This compared with a daily movement of only a few pips during the two years when the currency was pegged to the dollar. Banks are just starting to do more day-to-day speculation, adding to liquidity in the local spot market. Before the depegging, the limited daily swings meant all trading was almost a pure reflection of supply and demand, with the PBoC keeping the market in check.
Realised volatility in dollar/yuan has jumped as spot has started swinging more sharply within the daily trading band on the official CFETS platform.
Watch the state-owned banks: The PBoC is apparently fostering two-way trade within the daily trading band for the spot yuan rate, trying to get banks and companies accustomed to greater volatility and to hedging currency risks.
But during the peak of speculation on yuan gains early last week, the PBoC used state banks to buy dollars in hefty chunks, effectively limiting the market’s ability to short dollar/yuan — especially since banks are not allowed to hold short positions overnight. Dealers said the state banks scooped up dollars at a wide variety of levels, suggesting the authorities were not trying to defend the yuan at a certain level.
These mechanisms are a step back from direct intervention by the PBoC in trading, often employed in the post-revaluation phase of yuan appreciation from 2005 to 2008 and during the de facto dollar peg of the past two years. Dealers also believe the PBoC may have also adopted a new formula for setting the mid-point, or its reference rate, for the daily trading band.
It appears it sets the mid-point using the yuan’s close on the previous day plus overnight moves in the dollar index, making the mid-point market-oriented rather than an expression of the central bank’s desires as before. But traders expect the PBoC to keep the mid-point as a ready weapon for the PBoC for limiting any yuan moves during times of market volatility. The PBoC consults with banks but keeps the market in the dark as to how it sets the rate.
During the peg, the PBoC tweaked the mid-point by only one or two pips each day. Any trades happened far from the reference rate on a given day would have to be covered around the mid-point in subsequent days, discouraging moves far from the mid-point.
Since the depegging, the yuan has risen as much as 0.83 percent as the PBoC tolerated a rise to a post-revaluation high of 6.7700 against the dollar on Friday. While the new regime has still disappointed critics in the United States, Chinese market players believe that Beijing will not make any further concessions and that new pressure from US lawmakers — some of whom believe the yuan is undervalued by as much as 40 percent — would likely backfire. reuters