Yuan bounces back to end longest losing streak, after People’s Bank of China says it will support currency

PUBLISHED : Tuesday, 03 July, 2018, 10:26am
UPDATED : Tuesday, 03 July, 2018, 5:20pm

The yuan endured a roller-coaster ride on Tuesday, bouncing back sharply in the afternoon from a 11-month low in the morning, after the People’s Bank of China issued a statement during the lunch break in trading, saying it would support the currency.

The Chinese currency was trading at 6.70 against the US dollar in the morning amid worries about an intensified trade war between the United States and China. The onshore and offshore yuan rose by more than 500 basis points to 6.60 levels on Tuesday afternoon, following the Chinese central bank’s statement.

The offshore yuan, traded by international investors, was changing hands at 6.6818 to the US dollar at 4pm in Hong Kong, 508 basis points above its rate – 6.7320 – in the morning, which was 0.7 per cent lower than Monday’s close. It last traded below 6.70 on August 8, 2017.

The onshore yuan, traded on the mainland, recovered by 521 basis points to trade at 6.6647 at 4pm, up from 6.7168 per US dollar in the morning, which was 0.9 per cent lower than Monday’s close.

Offshore yuan drops faster than onshore currency as trade war fears, central bank policies spook international investors

The sharp decline in morning trade has been attributed to traders betting on the Chinese central bank further weakening the yuan in preparation for an intensified trade conflict with the US. As of Tuesday morning, the offshore yuan had dropped for 14 consecutive days and was down by a total of 5.4 per cent from June 13. Its losing streak started the following day, after the PBOC opted not to follow the US Federal Reserve in raising interest rates.

The central bank’s statement at lunch, however, put an end to this losing streak. At the same time, mainland China media reported that banks would also support the currency.

Pan Gongsheng, the head of China’s foreign exchange regulator and a central-bank deputy governor, told a forum in Hong Kong on Tuesday that China has the “fundamentals, capability and confidence” to keep the currency “generally stable at a reasonable and balanced level”.

The PBOC, posted a Q&A with its governor Yi Gang on its official website after lunch. Yi said the recent fluctuation of the yuan was “mainly caused by a strengthening US dollar and external uncertainties”.

He then said China’s economy is being transformed into a high-quality growth model, with financial risks under control and capital flows balanced, while the PBOC will work to keep the yuan “generally stable at a reasonable and balanced level”.

Financial News, a state media outlet under the PBOC, said financial risks “were building”, while the dollar may start to come under pressure, in a story published on Tuesday morning.

The onshore yuan strengthened late in the morning, and was trading at 6.6958 by 2pm. By 3pm, the offshore yuan was also back above the 6.70 level, recovering 396 basis points from the lowest point of the morning to trade at 6.6936.

Traders said some major state-owned banks were seen swapping yuan for dollars in the futures market and immediately selling some of them into the spot market, which helped shore up the Chinese currency, Reuters reported.

The PBOC on Tuesday lowered the yuan’s midpoint fixing rate by 0.5 per cent, or 340 basis points, to 6.6497 against the US dollar, having raised it by 0.01 per cent on Monday. Until Friday, the central bank had set the currency’s midpoint lower in the previous eight trading days.

“Analysts are widely speculating that the PBOC is willing to see a weaker yuan to prepare for the impact of the trade war,” said Jasper Lo, chief investment strategist at Hong Kong-based Eddid Securities and Futures.

“The current trade war is not just leading to a weaker yuan but also a weaker trend for other emerging market currencies. Traders widely believe US President Donald Trump is very keen on pushing the trade war against China and other countries, and this will lead to a strong US dollar against other currencies. The yuan is likely to trade around 6.70 level for a while.”

Lo, however, does not believe it will decline much further. “The yuan has gone down a total of 5 per cent in the past 14 trading days. The level of 6.70 per US dollar will be a resistance level. The PBOC would like to see a weaker yuan but does not want to repeat the mistake it made in August of 2015, when it fell more than 2 per cent in one day,” Lo said.

“The market then drove the yuan down much lower and that led to a massive capital outflow. China would not like to see that happen again. If the yuan drops any further, the PBOC is likely to take action to support it.”

Tai Hui, chief market strategist for Asia-Pacific at JP Morgan Asset Management, however, said it was unlikely China was using yuan depreciation as a tool in its trade negotiations with the US.

“A weaker yuan is seen by some as a warning shot to the US over the trade war. I am still not convinced that this is a credible threat. First, we have already seen the impact on Chinese investors’ anxiety over a weaker currency and subsequent capital outflow in 2015 and 2016. This is not a can of worms that Beijing wants to open again,” said Hui.

“Second, for all the recent concerns over Chinese companies and their US dollar bonds, a weaker yuan would further increase the pressure on weaker companies to service and repay their US dollar debt. Hence, an arranged yuan depreciation could lead to damage to the economy as much as the original problem [avoiding a trade war] Beijing is trying to tackle.

“The idea that the yuan has weakened on the back of a strong US dollar is less of a valid argument in the past two weeks since the trade-weighted basket has also weakened sharply. It does reflect the narrowing spreads between US dollar and yuan interest rates. Last week’s reserve requirement ratio cut, perhaps, has exacerbated this move,” Hui added.