“You can’t ignore the policy signals,” Eddie Cheung, an EM strategist at Credit Agricole, said Friday.
He was referring to the PBoC, and the “signals” the central bank sent late this week about yuan strength.
In short, China has seen enough. At least for now.
The PBoC despises a one-way bet, and that’s just what the yuan had become after appreciating to the strongest against the dollar since the eve of Donald Trump’s trade war (simple figure below).
There are good reasons for the yuan’s gains. Some have gone so far as to call it the new “hard currency” in a world of developed market debasement and monetary debauchery.
A less colorful assessment is just to say, as TD’s Alex Loo did Friday, that “the ongoing strength reflects China’s external position, FDI and portfolio inflows.” Export strength and foreign inflows into local fixed income have bolstered the currency.
The fundamental drivers are compelling, but the PBoC isn’t keen on what it famously calls “herd behavior.” Again: One-way bets, in either direction, are never tolerated in perpetuity. Late last month, The China Foreign Exchange Committee (it’s an organ of the state) suggested lenders be more vigilant about speculative FX trading and ensure positions are “risk-neutral.”
After weeks of gentle signaling, including a “request” that financial institutions kindly abstain from one-way bets, the PBoC finally stepped in. First, they hiked the FX reserve ratio, a tool the PBoC last deployed in May. 6.40 looked like a line in the sand then. This week’s intervention suggests it’s still symbolic.
As you can clearly see in the visual (above), the impact of May’s FX RRR increase was fleeting. Although the latest move “could temporarily slow CNY appreciation, pressures remain as Chinese corporates still have ‘unexplained USD holdings’ on hand, the goods trade surplus might stay high and structurally we could see continued inflows to RMB assets from global investors,” Goldman remarked.
Perhaps sensing the move would prove insufficient, the PBoC on Friday set the fix 179 pips above consensus (figure below).
That was a record and it was all the more notable considering Thursday’s fix was itself the weakest versus the average estimate in two months.
For some, the anomalous fix was uncouth. Plainly, it suggested the PBoC has reinstated the counter-cyclical adjustment factor, a somewhat blunt tool introduced in the summer of 2017 and shelved in October of last year.
“The arbitrary adjustment to the fix has been so prevalent since September that I don’t see why they don’t just formalize it,” Alvin Tan, head of Asian FX strategy at RBC, said. “That would strengthen the market’s perception that the PBoC is getting serious about at least slowing down the renminbi.”
ANZ suggested Friday’s fix might be a “one-off” aimed at resetting expectations. “Ultimately, given the strong trade surpluses and portfolio inflows, and importantly an absence of outflows, there is still scope for yuan to appreciate,” the bank remarked.
And that’s the problem if the PBoC does want a weaker currency — the fundamentals are sound.
Notably, the huge deviation in the fix came after Treasury’s semiannual foreign exchange report. It’s at least possible the PBoC wanted to get clear of that before making it obvious that the counter-cyclical factor is back. Although yuan watchers have been “in on it” (so to speak) since September, what you see the second visual (above) is flagrant. While it might curb appreciation pressure, explicitly announcing the resumption of the CCF could raise a red flag at Treasury.
“While China was nowhere close to receiving a manipulator tag, the report did raise concerns about ‘unofficial’ FX interventions made through state banks and emerging in net foreign exchange settlement data,” ING remarked.
Commenting in a Thursday note, Goldman wrote that based on the bank’s estimates, the PBoC has “implicitly” brought back the CCF. “An official recognition by stating ‘herding behaviors exist in the FX market and thus policymakers need to guide expectations’ would send a stronger signal against appreciation and also allow the PBoC to add more depreciation bias in the daily fixing,” the bank added.
