Yuan surge shows traders' faith in hands-off central bank

Yuan surge shows traders' faith in hands-off central bank

HONG KONG (BLOOMBERG) – An unstoppable ascent in the yuan is signaling Beijing’s growing ease with gradually freeing up one of the world’s most tightly-managed currencies. Since the yuan hit a six-year high on a trade-weighted basis on Nov 17, the People’s Bank of China (PBOC) has set the currency’s daily reference rate at only mildly weaker-than-expected levels.

The central bank also has refrained from delivering stronger warnings to investors following a gentle reminder of not making one-way bets. Meantime, a key yuan volatility gauge is near a two-year low, suggesting that traders aren’t bracing for sharp price swings.

The composure and restraint that Beijing has demonstrated in the face of a resurgent yuan shows policy makers remain confident in their ability to prop up a slowing economy without having to rely on a cheaper currency, at least for now.

It stands in stark contrast to the situation in 2015, the last time the yuan was this strong, when the PBOC shocked markets with a surprise and messy currency devaluation. “This time is different because the currency regime is more flexible,” said Mr Eddie Cheung, senior emerging-market strategist at Credit Agricole CIB in Hong Kong.

“There is now transparency around the yuan basket and markets can gauge the intentions of the PBOC, which allows the currency to be more market-driven.” The yuan has gained over 2 per cent against the dollar this year to beat all its Asian peers, thanks to robust exports and capital inflows. The Bloomberg replica of the CFETS RMB Index, which tracks the yuan’s performance against major trading partners, has surged more than 8 per cent.

For now, there’s little to suggest that the yuan’s appreciation will slow, even as the dollar has strengthened globally amid expectations for a faster U.S. exit from economic stimulus: China’s net foreign exchange settlement on behalf of banks’ clients has been positive since the third quarter of last year, an indication of stronger demand for the yuan.

Credit Agricole’s Cheung said he expects the Chinese currency to be worth around 6.30 per dollar at the end of 2022.

To be sure, the PBOC could still step in to slow the yuan’s advance if it risks undermining the country’s so far resilient exports. And history shows it has an array of tools at its disposal. For instance, in early 2018, China’s central bank effectively gave banks the green light to submit quotes for a weaker yuan reference rate, causing the currency to head for its biggest drop in two months immediately afterward.

Alternatively, the PBOC could also adjust the supply of dollar liquidity onshore, as it did earlier this year by asking banks to hold more foreign currencies in reserve, to cool the yuan’s rally.

“The export or the trade surplus advantage will eventually diminish and China definitely doesn’t want to see the yuan being too strong,” said Mr Bruce Zhang, portfolio manager at CSOP Asset Management. Nor do the authorities want the currency to be excessively weak, he added.

This comes amid renewed market volatily on Friday (Nov 26) as investors responded to news of a new coronavirus variant, Omnicron, which was identified in S. Africa.

The foreign-exchange market stabilised Monday amid signs the Omicron coronavirus variant causes only mild symptoms and vaccine reformulations against it can be achieved quickly.

The U.S. dollar rose modestly against the yen and euro in early Asia trading. The currency of South Africa, where the variant was identified, rose as much as 0.9 per cent against the greenback, and Mexico’s peso echoed those gains.

The Australian dollar gained against the U.S. currency and yen on short-covering as part of a broader recovery in commodity currencies.

The steady opening comes after investors dumped stocks, commodities and non-haven currencies after the highly mutated Omicron variant sparked international travel bans, spurring concern the fragile global economic recovery will come grinding to a halt.

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