‘What’s next?’ traders ask, after PBOC stays on the sidelines as yuan weakens past key level
Currency experts and traders are rethinking assumptions after the PBOC surprised the forex market by letting the yuan weaken beyond 6.8 per US dollar
The sharp depreciation in the Chinese yuan has broken the market’s expectation that monetary authorities will step in when the currency falls below the psychological level of 6.8 per US dollar.
Most analysts now believe that China’s central bank will tolerate an even weaker yuan as long as it does not trigger market turmoil. Another idea taking hold is that it’s hard to reverse the declining trend before the country’s economic fundamentals improve.
The onshore and offshore yuan both weakened by more than 1000 basis points, or 1.6 per cent, in less that 10 trading days, breaking several psychological lines within a week. The offshore and onshore yuan was quoted at 6.9 and 6.89 per US dollar, respectively, late Friday afternoon.
As of Friday, the People’s Bank of China has lowered its daily reference rate for 12 consecutive trading days, or a cumulative 1,305 basis points or near 2 per cent to reach 6.8796 per US dollar, the lowest level since June 24, 2008.
This is unusual even for a year as volatile as 2016.
Huang Yiping, an advisor to the People’s Bank of China, said on Thursday that the depreciation was caused by a strengthening US dollar, increased demand for assets diversification as well as China’s economic slowdown.
China has to rely on structural reforms to fundamentally reverse the weakening trend of the yuan, said Huang.
In contrast, on the same day, Yao Yudong, the former director of the finance research centre of the PBOC said, “don’t bet on the yuan’s long-term depreciation because that’s impossible.”
He cautioned against making one-way bets on the US dollar.
“The strengthening of the US dollar index is fragile and it’s almost reached the peak,” said Yao. “When the British pound and the Japanese yen rebound, the yuan will start to appreciate.”
Confused by the conflicting voices, many are seeking the government’s official position to the yuan’s depreciation.
One consensus view had been that authorities would prevent the yuan from weakening beyond 6.8 per US dollar. Earlier this year, Reuters reported, citing policy sources, that China’s central bank would allow the currency to depreciate to support the economy, but limit the drop at or near the target level.
Now, it seems the market are wrong about the PBOC.
“Given the slowing economy and continuing capital outflows, the depreciation pressure will last for a while,” said Hong Hao, chief strategist at Bocom International in Hong Kong.
“The central bank is likely to tolerate the yuan to weaken further as long as it doesn’t cause turmoil in China’s domestic financial markets,” said Hong.
The view was echoed by Zhong Zhengsheng, director of macroeconomic analysis at CEBM Group, who said in his research note that “the fact that the recent sharp depreciation of the yuan didn’t cause turmoil within China created conditions for the PBOC to tolerate increased fluctuation of the yuan.”
“The central bank still intends to release depreciation pressure through a ‘strategic depreciation’ which was in place since the beginning of the year,” said Zhong.
Other analysts agree that the unofficial policy is for gradual depreciation with the yuan tracking a basket of trade-weighted currencies, as the dollar appreciates against everything else.
Notably, despite a sharp depreciation of the yuan against the US dollar, the CFETS RMB Index, a gauge of the yuan’s strength against 13 trade-weighted currencies, has managed to stabilise.
Donald Trump’s election win gives the Chinese central bank another opportunity for the central bank to allow the yuan to weaken passively against the US dollar.
The US dollar index, a gauge of the strength of the greenback against a basket of major currencies, broke 100 on Monday and has been on a steady rise throughout the week.
Looking ahead, “as the regulator has refrained from stepping in, the yuan is expected to remain under pressure”, forex analysts at China Merchants Bank said in a research note.
“Asian currencies are on the defensive as US Treasury yields spike and capital outflows accelerate,” said Heng Koon How, senior forex investment strategist Asia Pacific at Credit Suisse.
“Our forecast for the exchange rate of the yuan against the US dollar in 12 months is 7.10,” said Koon How.
Meanwhile, other analysts highlighted a range of factors, including a possible reset in trade relations with the US trade under a Trump administration.
“A toxic combination of steeper US yield curve, along with the ever present discussion of a trade war with the US, dominates the current currency landscape, which favours a weaker yuan,” said Stephen Innes, senior trader at OANDA. “The inflating mainland asset bubbles and uncertainty over China’s growth trajectory will continue to provide a tailwind for the current US dollar move higher.”