The PBoC on Monday moved to support the Chinese Yuan, or Renminbi as it also known as it continues to crumble. China’s central bank said it would cut the foreign-exchange reserve requirement ratio by 2 percentage points to 6% from Sept. 15. The move releases around $19 billion into China, saving Chinese bank needing to sell yuan to buy that amount of foreign currency. Ahead of the move the yuan is trading around a 2 year low of 6.94 per U.S. dollar in the more freely traded offshore market, its year-to-date decline against the dollar to 8.4
It was the second time the central bank cut the foreign-exchange reserve requirement ratio this year, after a 1 percentage point cut in April, during another period of yuan weakness. After the PBoC announced the move at around 5 p.m. Beijing time the dollar moved from more than 6.95 yuan in the offshore market to around 6.94 per dollar.
The dollar has rallied unrelentingly for most the year as the Federal Reserve pivoted to more aggressive rate increases. The forward margin between the Yuan and the USD has widened as the PBoC’s rate cuts have been made it less attractive to hold the yuan against the dollar because the U.S. Federal Reserve has gone in the opposite direction.
The surge in interest rates and the de-risking of the world is one factor but there are other particular influences. With regards to volatility in currency markets, these huge moves act like rubber bands when its crowded. The more stretched an exchange rate is, the bigger, faster and more painful the eventual correction. What is the catalyst? There is the obvious, a peace deal in Ukraine or a dovish Fed. However, it is usually something not expected.
The reality is the recovery from the pandemic is not yet complete and we have the specter of a US recession darkening the scene. The strong dollar adds to the pressure to tighten as weak currencies exacerbate imported inflation.
- USD/CNY is the onshore yuan and is permitted to trade plus or minus 2% from the daily reference rate.
- CNH is the offshore yuan. USD/CNH has no restrictions on its trading range.
- A significantly stronger or weaker rate than expected is typically considered a signal from the PBOC.
- The IMF lifted the yuan’s weighting in its Special Drawing Rights currency basket in May
Yuan weakness continued with the dollar’s rally gathering pace in the fallout from Jackson Hole. China’s Yuan, Japanese Yen and the Euro have seen significant moves given their geopolitical dynamics. The Yuan slipped to a two-year low of 6.923 after and ended August with a decline of 2.2%, a sixth month of losses with its real estate crisis overhanging. The yuan opened the following Monday at 6.94 per U.S. dollar in the more freely traded offshore market, its year-to-date decline against the dollar to 8.4%.
Last Tuesday morning, the PBoC set the midpoint fix at more than 6.85 yuan to the dollar. It is likely to depreciate further as the country’s central bank moves to combat a slowing economy and a deep housing downturn. China took steps to support the weakening yuan Thursday, after hitting fresh two-year low. The People’s Bank of China set its yuan reference rate at a stronger-than-expected level for the managed currency. The move signaled the PBoC wants to slow the pace of yuan depreciation.
The latest selloff in the yuan, or the renminbi accelerated as the U.S. dollar marched higher. Recent data releases also show China’s economy in rude health. Factory output, investment, consumer spending and youth employment numbers in July all pointed to broad economic weakness. China’s economy contracted by 2.6% in the April-to-June quarter from the first quarter of the year, official data released last month showed.
During July the PBOC cut the 5-year loan prime rate to 4.45% from 4.6% to boost the economy and cut short term rates further this past week. Beijing has warned against criticism of its dynamic zero-COVID policy. The zero-tolerance approach, which depends on strictest lockdowns and mass testing, has weighed heavily on the already slowing economy and raised the need for further policy easing.
The yuan is set to slide past 7 per dollar with scarcely a murmur as a range of metrics show the currency would still be relatively expensive against its non-dollar peers, analysts say. The authorities will allow the currency to weaken past that key psychological barrier and merely seek to prevent a rapid decline that may cascade into a disorderly selloff, according to Societe Generale SA and Barclays Plc, among others.
“I don’t think the People’s Bank of China aims to defend seven,” said Wei Yao, chief China economist at Societe Generale in Hong Kong. “It’s the speed that matters. The yuan will still be expensive even after dollar-renminbi breaches seven,” she said,Bloomberg Sep 1
On Aug. 19, the central bank also signaled its preference for a weaker yuan by setting its daily midpoint fix for onshore trading at more than 6.80 against the dollar. This was the first time it had crossed that level in 23 months. The PBOC allows the currency to trade within a daily range of 2% up or down against the dollar from its target level. The market is asking where the upper band is now?
Then on Tuesday August 23, the PBoC set the midpoint at more than 6.85 yuan to the dollar. A weaker currency helps China’s exporters by making their goods cheaper. But it creates another headwind for foreign investors in stocks and bonds in mainland China by eroding their value. So far this year, international institutions have pulled more than $82 billion from yuan-denominated bonds, a record outflow for the asset class.
The forward margin between the Yuan and the USD has widened as the PBoC’s rate cuts have been made it less attractive to hold the yuan against the dollar because the U.S. Federal Reserve has gone in the opposite direction.
April 28 – Bloomberg (Sofia Horta e Costa and Tania Chen): “When China’s tightly managed currency depreciates dramatically against the dollar, it can be hard to stop. More than six years after China’s shock 2015 devaluation roiled global markets and spurred an estimated $1 trillion in capital flight, the yuan is weakening at a similar pace. Onshore it’s lost nearly 4% in eight days, while the offshore rate is heading for its worst month relative to the greenback in history. Selling momentum is the strongest since the height of Donald Trump’s trade war in 2018.”
China Foreign Exchange Trading System
Asian currencies have had a dismal year. The Japanese Yen and South Korean won have been falling sharply lower in 2022. The won has weakened more than 8% this year, following an 8.6% drop in 2021, which was the fastest annual fall since 2008. The Won fell below the much talked about psychological threshold of 1,300 per U.S. dollar for the first time in 13 years
The Fed’s tightening cycle has triggered a widespread selloff in Asian currencies this year, including more than 10% declines for the Japanese yen and the Korean won. China’s central bank last let the yuan depreciate past 7 to the dollar in August 2019, during the trade war between Beijing and Washington.
The yuan however has held up better against other currencies this year. China Foreign Exchange Trading System, an arm of the central bank, measures the performance of the currency against a basket of 24 currencies, including the dollar, yen and euro and lesser-traded currencies such as Polish zloty and Russian ruble the WSJ reported. That yuan index was roughly at the same level it was at the start of 2022, according to the most recent data published on Aug. 19.
John Maynard Keynes, 1920: “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction and does it in a manner which not one man in a million is able to diagnose.”
Also factor in that Asia is the epicenter of technology manufacturing – with the global “tech” Bubble in grave jeopardy. The confluence of China’s bursting Bubble, Japan’s foolhardy monetary policy gambit, and highly levered systems puts Asia today on a Collision Course with rapidly deteriorating macro and micro fundamentals. I’ll assume mounting hedge fund and derivative issues.
Yen weakness places Chinese manufactures at a competitive disadvantage, which has emboldened Beijing to play the currency devaluation card in an attempt to mitigate mounting economic woes and dumping of Chinese assets. Higher-yielding Chinese debt securities are losing their relative appeal (in a rising yield world), and now even the perceived stability of the Chinese currency is in question.
A slump of that to 150 may convince China to intervene in the currency market to protect its own flagging economy and it would be perfectly rational for it to do so, former Chief currency economist at Goldman Sachs Jim O’Neill said:
‘If the yen keeps weakening, China will see this as unfair competitive advantage so the parallels to the Asian Financial Crisis are perfectly obviously,’ ‘China would not want this devaluing of currencies to threaten their economy.’”
Sources: TC WSJ
From The TradersCommunity Research Desk