Over the course of the last three weeks, China has taken a three-pronged approach to shoring up the yuan.
In the face of ongoing trade tensions and the threat of a spillover from the slide in the Turkish lira, Beijing reinstated forwards rules (August 3), chided onshore banks for selling RMB (August 7) and moved to squeeze offshore liquidity (August 16). The yuan has also been buoyed recently by lower-than-expected USDCNY fixings. Here’s an annotated chart that shows you the evolution of the PBoC’s efforts to manage the RMB:
Recent efforts to support the currency appear designed to guard against the psychologically important 7-handle, beyond which some fear capital flight could begin to pick up. It’s also possible Beijing believes they’ve accomplished what they can conceivably accomplish with yuan depreciation when it comes to shielding the economy and are now prepared to move to something akin to “phase 2” in their strategy to fight the trade war.
The depreciation in the yuan over the past several months has completely negated the effects of the first two rounds of 301 investigation-related tariffs before they were even fully implemented. Going much further down the depreciation road not only risks capital flight, but also chances being branded a currency manipulator officially (as opposed to unofficially, on Trump’s Twitter feed).
The question, then, is what steps does China take going forward assuming trade frictions continue to weigh on yuan sentiment, making the three measures mentioned above inadequate to stop the decline? As BNP’s Ji Tianhe wrote last week, “the three channels of downward pressure on the RMB are now restricted, [so] we think the USD will be the main driver of USDRMB.”
Well, unless the President manages to bully the Fed into taking a pause or unless there’s a significant enough downturn in the U.S. economy to catalyze dollar weakness, it’s likely that this week’s Trump-inspired declines in the greenback will prove fleeting.
Enter the counter–cyclical adjustment factor.
We’ve suggested for months that it was just a matter of time before the PBoC started leaning on that again when it comes to containing yuan weakness.
[That "I told you so-ish” statement comes with the usual caveat: we make no claims on being prescient in these pages – rather, we make claims on stating things that appear to us to be common sense, and this was one of them]
“China is about to start leaning more heavily on the counter-cyclical adjustment factor to guide the yuan”, we wrote on August 7, when the PBoC warned banks about “herd behavior” in the FX market. That was just the latest example. Back on July 7, we talked about this at length, recounting how it came into being and putting it in the context of the August 2015 devaluation.
Let’s take a trip down memory lane here for a minute. Here’s one of my all-time favorite characterizations of the 2015 devaluation from BNP’s Mole Hau (I think he may be at ICBC now):
Whereas the daily fix was previously used to fix the spot rate, the PBoC now seemingly fixes the spot rate to determine the daily fix, (thus) the role of the market in determining the exchange rate has, if anything, been reduced in the short term.
Last summer, when the yuan was sitting around 6.90, the PBoC introduced a laughably opaque “counter-cyclical adjustment factor” designed to engineer a short squeeze in the yuan, perhaps in an effort to placate Trump. That amounted to a rolling back of whatever liberalization was ostensibly embedded in the “new” FX regime that went into effect in August 2015. Effectively, they went back to manipulating the fix to control the spot but they also retained the discretion to intervene in the spot market (and they subsequently did), which effectively meant that last summer, they were manipulating the fix and the spot and because the latter informs the former, the whole thing was fixed (#RIGGED STOP HUNT!).
That led directly to a historic rally in the yuan versus the dollar that ran so far, so fast Beijing ultimately had to put the brakes on the situation in early September by relaxing rules on forwards put in place following the 2015 devaluation.
Well, sure enough, the PBoC is dusting the CCAF off after sidelining it in January.
According to the ubiquitous “people familiar with the matter” who spoke to Bloomberg, the central bank hopped on the phone with banks that contribute to the fix on Friday and “suggested” they start using the adjustment factor again when fixing their fix submissions (so to speak).
This will start on Monday, the sources said. One bank has reportedly already resumed using the CCAF.
“Global risk-sentiment in one asset: Offshore Yuan sees a powerful reversal STRONGER again overnight and is back through the ‘centrifugal pull’ of 6.85, to 6.838 all the way from ~6.90 earlier (!)”, Nomura’s Charlie McElligott exclaimed, in his Friday note.
Again, it’s unclear whether this is related to pressure from Steve Mnuchin (the Treasury supposedly pushed for a stronger yuan via low-level negotiations this week with a Chinese delegation) or whether Beijing simply isn’t prepared to stomach any more weakness.
Whatever the case, to the extent you think the weakness in the yuan was contributing to global risk-off sentiment, you can expect China to start guarding against that next week with the adjustment factor.