First thing this morning, we spent more time than we probably should have writing about China’s overnight move to make their “new” yuan fixing methodology official.
You’re encouraged to read the entire post here: Your “Unreal, Irrational, Herd Actions” Were Pissing China Off – But They “Fixed” It
Basically, the PBoC has kind of reversed course on what they did in August, 2015. Before 2015, they would use the yuan fix to control the spot. After the devaluation (which roiled global markets), they tried to transition to a system where the spot would dictate the fix, but when pressure on the spot gathered steam, they started burning through their reserves to control the trajectory of the devaluation. Ultimately, they ended up simply manipulating the spot to influence the next day’s fixing and at that point it wasn’t at all clear that much had changed in terms of the exchange rate being more market-driven.
Friday’s move simply put the onus back on the fix, which theoretically means the PBoC can control the spot without burning reserves.
Well this is actually pretty important, although Citi doesn’t necessarily agree with that assessment. For whatever it’s worth, you can find the bank’s take on all of this below.
While this change may not soothe investor concerns about the renminbi’s outlook over the medium term, it provides authorities another mechanism with which to check the pace of deterioration in sentiment in the short run. It thus makes it harder still for market participants to profitably ‘speculate’ on renminbi depreciation.
We note that evidence of capital outflow pressures had increased in the past few days (Figure 2). This may be reasonably explained, as strict enforcement of capital controls instituted at the turn of the year had only recently been relaxed. However, volatile onshore market conditions owing to the ongoing regulatory tightening could also be playing a role in encouraging capital outflows at this time. This shift in the fixing mechanism should help stabilize market concerns in the short run.
That said, it is also probable that today’s reports formalize the existing fixing mechanism. Market participants have many times noticed deviations in the fixing from expected levels, especially at times of elevated market volatility. It is thus not obvious that the reported shift presages a ‘new regime’ for the renminbi.
Indeed, we expect that during ‘normal’ periods — i.e., when the onshore FX demand/supply imbalance is neither excessive nor persistent — the midpoint fixings should be consistent with the formula in place since February 2016.
However, the morning fix may become delinked from the market price during times of persistent net FX demand/supply imbalances. Without a mechanism to push market prices towards the announced midpoint, the market could continue to trade on one or the other side of the USDCNY midpoint depending on the direction of the imbalance. At such times, FX intervention will become necessary to close the gap between the market price and the fixing.
It is thus possible that during such periods, the midpoint fixing could temporarily become unrepresentative once again. This was a key IMF criticism in 2015 that led to the Aug 11, 2015 shift in fixing mechanism (which many investors inaccurately refer to as a ‘devaluation’). During such periods, the outer extremes of the daily USDCNY trading band (+/-2% from the midpoint) may become more relevant for market participants than the midpoint (Figure 3).
In summary, we see today’s reports of a change in the formula used to determine the fixing of the daily USDCNY midpoint as helping to contain the pace of deterioration in market sentiment towards the renminbi. We do not view this shift as a regime change, and we anticipate that for the most part the USDCNY fixings will remain consistent with established pattern.
We reiterate our view that RMB could still trend lower vs. the CFETS tradeweighted RMB basket, in line with the trend of net capital outflows. However, at this stage we do not expect excessive pressure for depreciation vs. USD, owing not only to authorities’ demonstrated preference for stable conditions in the FX market, but also due to our view that the dollar will likely be range-bound in the near term.