Offshore yuan surges to a 6-month high as cash squeeze hits banks

Offshore yuan has risen to a six-month high, blamed on a cash crunch at Chinese banks and following the People’s Bank of China’s revision in the formula for calculating its daily yuan reference rate, in an effort to ward off capital outflows.

The overnight CNH Hibor, a gauge of offshore yuan funding in the interbank market, soared 1,572 basis points to 21.08 per cent on Wednesday, reflecting a liquidity squeeze and causing Chinese interest rates to rise at a faster pace than US rates.

The sharply higher yuan funding cost means those traders that use yuan proceeds to buy dollars, with much lower yields, will be hurt, said Ken Cheung, yuan strategist at Mizuho Bank.

“The tight yuan liquidity is influencing the currency spot rate, making the outlook of the currency more uncertain,” Cheung said. “Many foreign exchange traders are now becoming more bullish in the yuan.”

On Wednesday, offshore yuan rose 0.62 per cent to 6.7818 per dollar, the highest value since November, and breaking the key 6.8000 level. Onshore yuan was in turn dragged up, gaining 0.41 per cent to 6.8247 per dollar, also its strongest since November.

The People’s Bank of China (PBOC) fixed the daily yuan reference rate at 6.8633 per dollar on Wednesday, its strongest level since May 18.

Last week, the PBOC added a “counter-cyclical adjustment factor” to the formula calculating its daily yuan reference rate. Analysts believe the revision will dilute the influence of the daily closing price against the dollar in the calculation, in an apparent effort to reduce its one-way market depreciation expectations.

The revision suggests the central bank’s determination in putting a floor under the yuan at 6.90 per dollar, where it has been trading over the past fortnight.

“Today’s liquidity squeeze seems very similar to what happened at the beginning of the year when the authorities were believed to have engineered a cash crunch to squeeze out yuan short-sellers,” Cheung said.

The soaring yuan funding rates and new methodology in the fixing comes amid concerns the US Federal Reserve will raise interest rates next month, which may boost the dollar against other Asian currencies, including the yuan.

China will also be keen to prevent any sharp declines in its currency this year ahead of the launch of the China-Hong Kong Bond Connect next month, and in a politically sensitive time, as the Communist Party’s most senior leadership is expected to change later this year.

In another sign reflecting stabilising sentiment in the yuan, Hong Kong’s yuan deposits rose to 528 billion yuan (US$77.4 billion) in April, the first gain in seven months and the highest level since September, according to data from the Hong Kong Monetary Authority.