China Seeks to Curb Relentless Yuan Gains With Surprise Fix

(Bloomberg) -- China’s central bank took further steps to limit the yuan’s strength, a day after policy makers made their most substantial move yet to rein in the currency’s surge against the dollar.

The People’s Bank of China set its daily yuan fixing at the weakest relative to estimates since Bloomberg began publishing the forecasts in 2018. The fixing came hours after the PBOC told banks to hold more foreign exchange in reserve, a move that effectively reduces the supply of dollars and other currencies onshore and puts pressure on the yuan to weaken. Still, it continued to strengthen in onshore and offshore markets on Friday.

Together the moves present the market with further signals that Beijing is wary of rapid gains in the exchange rate, given traders can unwind long positions just as quickly. Earlier this week the yuan advanced to its strongest level against the dollar since May 2018, with confidence boosted by official signals of more easing to support the economy.  

Authorities “don’t want too sharp an appreciation in a soft period,” said Ken Cheung, chief Asian FX strategist at Mizuho Bank Ltd. The PBOC needs to send a strong signal at a time when markets have become more bullish and the Federal Reserve has taken a more hawkish tone, he added. 

The PBOC on Thursday told banks to hold more foreign currencies in reserve for the second time this year, prompting the offshore yuan to drop to its lowest level this month. The currency is set to be Asia’s best performer against the dollar this year, bolstered by strong inflows from robust exports and foreign investment in onshore bonds. On a trade-weighted basis, the yuan is hovering near the strongest level since 2015.

The yuan reversed earlier declines to trade 0.2% stronger at 6.3650 per dollar at 3:09 p.m. local time, as most emerging-market Asian peers led by South Korea’s Won weakened against the greenback. Year-end currency settlement flows would likely be supportive of the yuan, United Overseas Bank strategists said, noting that the PBOC’s move to hike the reserve requirement ratio would reduce onshore liquidity of foreign currencies. 

The moves give a clear signal that authorities are seeking to draw a line under the yuan’s strength, and the currency may retrace toward 6.40 versus the dollar where it could stabilize, said Khoon Goh, head of Asia research at Australia & New Zealand Banking Group Ltd. 

The large deviation in yuan fixing relative to forecasts also raises questions as to whether the PBOC has quietly re-enabled the counter-cyclical factor, a tool last used in October 2020 that gives Beijing more influence to curb one-way moves in the yuan. Today’s weaker fixing could be due to its reintroduction if it wasn’t due to a one-off “reset,” Khoon said. Alvin Tan, head of Asia FX strategy at RBC Capital, said he suspects that the PBOC reintroduced the factor in daily fixing in September.

If the bump up in U.S. dollar cost of funding isn’t a large enough deterrent for speculators, other tools are available to the central bank, Citigroup strategists including Gaurav Garg wrote in a note. They could include further increases in the forex reserve requirement, lowering the short-term foreign debt ceiling, U.S. dollar buying intervention and re-introduction of FX forward risk reserves.

The currency’s appreciation has raised the appeal of yuan assets and accelerated capital inflows. Foreign funds piled a near-record amount of money into mainland shares on Thursday, after last month buying the most Chinese government notes since January. 

The PBOC set its daily yuan fixing at 6.3702 per dollar. The fixing limits the yuan moves by 2% on either side. 

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With assistance from Bloomberg