The onshore yuan narrowly averted logging an eleventh day of losses on Thursday.
The currency reversed course after Chinese Commerce Ministry spokesman Gao Feng appeared to extend something of an olive branch to the Trump administration in the trade war.
Were it not for the last-minute stick save, the currency’s losing streak would have been the longest on record in data going back to 2007.
The PBoC set the reference rate stronger than expected for a seventh straight day, as the central bank continues to lean into the counter-cyclical adjustment factor to convey a desire for stability in the face of market pressure.
At 7.0858 versus consensus of 7.1237, Thursday represented yet another day featuring a wildly strong fix. The deviation from market expectations has risen steadily over the past several sessions in the face of mounting trade tensions.
For days, the spot rate traded above the fix and for analysts and traders, that was seen as an increasingly untenable situation.
“Traders will be asking where is the limit of PBOC tolerance? Given that the central bank doesn’t usually wait for the yuan to reach its daily price limit if it wants to send a message”, Bloomberg’s Mark Cranfield wrote Thursday, adding that the onshore-offshore spread has narrowed, “which suggests investors see this as a sanctioned slow grind higher for the dollar, a stance supported by the FX options skew, which is only modestly in favor of yuan puts”.
Thursday’s indication from Beijing that China won’t immediately seek to escalate the trade war and that talks with the Trump administration are likely still on for next month will serve to take some of the pressure off, alleviating the need for the PBoC to lean aggressively on the CCAF. Of course, Beijing has many other ways of discouraging speculative bearish behavior in the yuan, but recent action and positioning doesn’t support the notion that the market was expecting rapid depreciation anyway, perhaps explaining why the central bank was satisfied with using the daily fixings to send a message as opposed to resorting to more draconian measures to curb depreciation pressure.
“Policymakers have been allowing the currency to depreciate to reflect numerous negative growth fundamentals, one of which is tariffs [and] this should continue to be the case going forward unless capital outflow pressure intensified or speculative positioning became excessive”, SocGen wrote this week, adding that “for USD-CNY to turn around, tariffs would need to be rolled back or global/China growth momentum would need to improve”. Thursday’s message from Beijing was a step in the right direction in terms of rolling back the tariffs, but we’re a long way from any kind of concrete steps in that regard.
The bank generally echoes other desks in its estimates of how far the yuan would need to fall in order to offset the planned tariffs from Trump. Per SocGen’s framework, USDCNY would “need” to rise to 7.26 on October 1 (30% on $250 billion plus 15% on the 1st tranche of $300 billion) and to 7.51 on December 15 (plus 15% on the 2nd tranche of $300 billion)”. Earlier this week, BofA projected that USDCNY would have to push all the way to ~8.19 in order to fully offset a hypothetical 30% tariff on the next tranche of Chinese goods (i.e., the remaining $300 billion in products that will be taxed at 15% from September 1 and December 15). For SocGen, the level is 7.95 to offset those prospective “worst-case” duties.
Ultimately, SocGen reminds you that although fundamentals can be “a powerful and overriding influence” on the Chinese currency, at the end of the day it’s all about the PBoC.
“They have tools to slow it down, limit, or fully halt depreciation”, the bank writes, enumerating the toolkit, including reserves, FX swap activities, bill issuance in Hong Kong, reserve requirement ratios, and capital flow restrictions. As far as the CCAF, SocGen reminds you that since it was reinstated in August of 2018, there “has been a systematic bias for USD-CNY to be fixed lower (CNY stronger)”. And by “systematic”, they mean more than three-quarters of the time.
As a reminder, things tend to go demonstrably “wrong” when the yuan is allowed to find its own “equilibrium”. That’s especially true now that the depreciation pressure is predicated on trade frictions.