The PBoC stepped in to stanch profuse bleeding in the yuan Monday, after the currency careened lower alongside Chinese equities.
Beijing cut the FX reserve ratio, partially undoing a December move aimed at slowing what, at the time, was unwanted appreciation. The one percentage point reduction (to 8%), is effective from May 15.
The offshore yuan trimmed declines following the move. At one point Monday, USDCNH breached 6.60, the weakest levels for the yuan since 2020 (figure below).
Chinese assets are under immense pressure as growth worries mount and authorities’ adherence to “COVID zero” threatens to put the Party’s GDP target out of reach.
On Monday, fears of a lockdown in Beijing triggered a collapse in Mainland stocks, which dropped the most since February 3, 2020, when markets reopened following China’s original lockdowns.
“I think the PBoC FX RRR rate cut is a reaction to the increased volatility and extremely choppy price action,” SPI Asset Management’s Stephen Innes said. “Generally, the PBoC is probably still fine with a weaker currency, but the FX RRR cut puts a lid on USDCNH for now.”
There’s talk of an FX war in Asia, where the yen’s historic string of losses may prompt a race to the proverbial bottom. The dynamic is, in part anyway, a product of a growing policy divergence between Asian economies and the Fed, which is belatedly embarking on what’s expected to be the most aggressive tightening campaign since Volcker.
Last week, the yuan fell the most against the dollar since the 2015 shock devaluation (figure below).
As Innes suggested, Beijing is likely ok with a weaker yuan, but things took a turn for the disorderly Monday, when the vol curve inverted. The PBoC didn’t protest with the fix, which may have been seen as a green light for traders to push the issue.
Bloomberg’s Mark Cranfield described last week as a “watershed” for dollar-yuan which, on Friday, accounted for a quarter of all FX options, a figure he called “stunning.”
“Yuan bears will also get a boost from a report that some of China’s largest banks are cutting deposit rate ceilings [which] could prompt some pushback from the PBoC, as the central bank would like to avoid the yuan becoming a one-way bet to the downside in the eyes of forex traders,” Cranfield wrote Monday, adding that “the shift higher across the CNH forwards curve shows that the buildup of yuan shorts is more than a month-end effect and underscores the upward path for the dollar.”
Early Monday, the BBG dollar index touched a 23-month high.
If you’re after a poignant one-sentence summary, you could suggest that market participants increasingly believe the only way for Beijing to hit the Party’s 2022 growth target is for authorities to guide the currency weaker.
If that’s accurate, it’ll be a delicate balancing act, as evidenced by Monday’s intervention. With the Fed set to tighten aggressively, a concerted effort in Beijing to weaken the currency risks exacerbating capital flight.
Perhaps that’s why Xi has been so adamant about exhorting developed markets to avoid abrupt monetary policy shifts.
Read more: A Currency War May Be Coming To Asia
