China’s central bank is trying to steal a march on the US Fed, by boosting the yuan
Bank’s moves are aimed at crushing speculators who have a bearish outlook on the yuan, by sending out a clear signal the country will not tolerate a weakening currency
The Chinese central bank is perfectly sensible in making preparatory moves well ahead of any likely rise in US interest rates in the middle of this month, analysts agree, by strengthening the yuan in an effort to prevent any further rise in capital outflow, that could affect the country’s economic mission of deleveraging.
But analysts still report the country is seeing sustained levels of capital leaving its shores.
Over the past ten days, the yuan has appreciated 1.1 per cent against the US dollar in the onshore market, and 1.5 per cent in the offshore market, where the People’s Bank of China (PBOC) has also engineered a spike in short-term interbank lending rate, a rare move in such a tightly managed currency market.
On Monday, onshore yuan closed at 6.8014 against the greenback, strengthened by 70 pips from 6.8084 from the opening price.
It set the reference rate at 6.7935 yuan per US dollar, stronger by 135 basis points, or 0.2 per cent stronger than Friday. Traders are allowed to trade 2 per cent either side of the reference point.
On May 26 the Chinese central bank announced it would tweak its mechanism for fixing the daily yuan rate by adding a “counter-cyclical adjustment factor”.
Traders believe the range of measures being made are aimed at crushing speculators who have a bearish outlook on the yuan, by sending out a clear signal the country will not tolerate a weakening currency.
Analysts with BofA Merrill Lynch said they believe concerns over the Federal Reserve’s potential monetary policy tightening on June 14 has certainly “added pressure on the PBOC [to make these move]”.
“The key motivation here is that while controls have been successful in reducing outflows, China continues to see sustained foreign exchange buying,” the report said.
Despite disappointing job data posted on Monday, market participants still largely anticipate the US Fed to raise its rates at its next meeting on June 14.
“China is especially vulnerable to Fed tightening as any renewed acceleration of capital outflows undermines its efforts to engineer successful deleveraging,” the BofA Merrill Lynch report added.
Aidan Yao, a senior emerging Asia economist at AXA Investment Managers, said the cycle of Fed rates had triggering repeated yuan devaluation and outflow over the past two years, and agreed the PBOC is under growing strain to prepare for the next eventuality.
“Debt levels in China are still high while deleveraging efforts, without triggering systemic risk, require accommodative liquidity conditions,” Yao said. “Any accelerated outflow following the Fed’s move may cause abrupt domestic liquidity tightening, which will leave the PBOC without responsive options – that partly explains why Beijing is moving early this time.”
But he considered the abrupt strengthening of the yuan might also be an over-reaction by the market, rather then direct willingness of the PBOC to keep it strong.
Andrew Baston, director of China research for Gavekal, underlined the possibility that the PBOC was moving ahead of the Fed, by guiding yuan expectations, but also said it was unlikely, having already risen rates in China recently, that rates here would rise further.
“If the PBOC is not planning to raise rates again in mid-June, then it knows it will have to counter market expectations, and that it might have to do so after the Fed move,” he said. “So it’s trying to push market sentiment in its direction ahead of time, and build up some potential defences against downward pressure on the renminbi.”
Financial institutions, meanwhile, are also revising up their outlook on yuan’s exchange rate.
Morgan Stanley revised up its value against US dollar to 6.90 by end 2017, from 7.10, and 7.0 by end-2018, from 7.24, as a tighter domestic policy stance can partly offset depreciation pressures from upcoming Fed rate hikes, a research note published on Wednesday said.