Beijing Has Seen Enough Yuan Appreciation

China has seen enough yuan appreciation.

On the heels of a virtually uninterrupted rally, the PBoC on Monday hiked the reserve ratio for banks’ foreign currency holdings. Starting in two weeks, financial institutions must hold 7% of their foreign exchange in reserve “in order to strengthen the management of foreign exchange liquidity,” a terse statement said.

It was the first move of its kind since 2007. The decision to make dollars and other FX more scarce onshore came as the yuan strengthened some 13% in just 12 months, taking the currency to levels last seen prior to Donald Trump’s trade war. The annotated figure, below, gives you a sense of things. If 6.40 was a line in the sand, it was well and truly crossed.

Beijing despises a one-way bet or, perhaps more aptly, the perception among market participants that the currency is a one-way bet.

The fix was weaker than forecast Monday following comments from a former central bank official who branded the yuan “overbought.” The PBoC’s Financial News ran a commentary arguing that a Fed taper, the strength of the US economic recovery, an abatement of the pandemic globally and, amusingly, the potential bursting of asset bubbles in the US, could catalyze yuan depreciation.

The market was unimpressed. The yuan barely reacted to the latest round of verbal intervention. In and of itself, it doesn’t seem particularly likely that increasing the reserve ratio for foreign exchange holdings will be sufficient to arrest the rally. Rather, it’s a warning shot meant to remind market participants that Beijing can do quite a bit more than talk.

Standard Chartered’s head of China macro strategy, Becky Liu, told Bloomberg that Monday’s move likely wasn’t “a one-off change, but [rather] the start of a trend.” Obviously, Beijing could lean more heavily into the daily fixings or simply intervene directly. If you’ve followed the PBoC’s currency management efforts over the past half-decade, you know the toolbox is virtually bottomless.

Guan Tao, another former official, said Monday that hiking the forex reserve ratio demonstrated the PBoC’s steadfast determination to curtail rapid appreciation in the yuan. The central bank, Guan reiterated, has additional tools if speculation becomes rampant. Monday’s move will apparently freeze some $20 billion of liquidity.

Last week, the yuan rose to the strongest against the basket in more than five years (figure below). Some suggested China might countenance additional appreciation in an effort to help alleviate the strain from higher commodity prices and/or to offset inflationary pressures before they manifest in higher consumer prices. Domestic demand (at least as proxied by retail sales) is still a bit tepid.

Higher yields and a robust recovery have bolstered the currency and calls for additional appreciation (to levels last seen prior to the August 2015 devaluation) may have finally unnerved officials. In 2021, the yuan is stronger versus 25 of 31 major currencies.

A few days ago, following a meeting between the PBoC, SAFE and market participants, the central bank not-so-subtly warned that “no one can accurately predict the exchange rate.”

The yuan, officials reiterated, can appreciate or it can depreciate. “No matter if it’s in the short-term, mid-term or long-term, it’s certain that predictions of the exchange rate won’t be accurate,” a statement declared.