(Bloomberg) -- China stuck to a pattern of keeping yuan weakness contained as pressure from a resilient dollar and poor investor sentiment pushes it toward a policy red line.
The People’s Bank of China kept its daily reference rate for the managed currency broadly unchanged, implying to traders that yuan stability is key. China sets the so-called fixing at 9:15 a.m. local time, around which the currency is then permitted to trade in a 2% range.
Traders have been eyeing the fixing for signs of where Beijing wants to guide the yuan after it weakened to within a whisker of the edge of its trading range last week. China’s policymakers have been vigilant of currency pressure which can spill over to local stocks and bonds, despite the fact that the country’s export engine would benefit from a weaker yuan.
“Such a move to keep the fix steady should dampen any form of imagination that markets may have on steady RMB policy,” said Christopher Wong, an FX strategist at Oversea-Chinese Banking Corp. “There is lingering speculation of a further weakening in the yuan but that’s not the message policymakers want to send out.”
Recent resilience in the dollar — a result of bets that the Federal Reserve will keep its policy rates higher for longer — is making the PBOC’s mandate of steadying the yuan even more difficult. The currency has also come under pressure as investors sour on the prospects for China’s economic growth.
Stability Prized
Stability tends to be prized because rapid yuan drops can also lead to a vicious cycle of capital outflows and exacerbated losses. As a regional currency anchor, any message which triggers yuan volatility can quickly spill over into other markets.
The yuan traded little changed around 7.2330 per dollar after the steady fixing, which was set at 7.0947. China’s large state-owned banks sold dollars in the morning but only in limited quantities, according to traders who asked not to be named as they were not authorized to speak publicly.
For Fiona Lim, a senior FX strategist at Malayan Banking Bhd., the new line in the sand for the yuan seems to be around 7.24 per dollar given Monday’s fixing. The PBOC may only allow its currency weaken beyond that level when the broader market environment supports significant dollar strength, she said.
That’s a view shared by Fidelity International economist Peiqian Liu.
“If dollar strength is more persistent and structural in nature, we could see the PBOC gradually loosen its control over the fix but if it’s more speculative and volatile, the central bank may prefer to keep the yuan fix stable,” she said.
Red Line
Complicating matters is the yuan weakening toward the edge of its trading band.
The PBOC has stepped in aggressively to stabilize the yuan on each of the five occasions it neared that policy red line in past years. It has adopted tools ranging from verbal warnings to boosting the cost of short wagers against the currency.
The yuan has never moved outside of its permitted range in history. So there is little guidance on what may happen to China’s spot market if the currency tries to touch the weak end this time around.
What’s more certain is that investors will likely see trading disruptions, with some transactions not being able to go through. That’s based on what happened in a corner of the spot market last week, when traders weren’t able to execute some trades as the yuan neared the weak end of the band.
“I think the pressure is rising for an increase in volatility for both fixing and spot and it’s increasingly difficult for the PBOC to draw a hard line here if the dollar continues to strengthen,” said Xiaojia Zhi head of research at Credit Agricole CIB. “That said, the PBOC would remain mindful to manage the expectations.”
--With assistance from Ran Li, Iris Ouyang and Wenjin Lv.