Weekly Spotlight: China Unleashes the Yuan

Talking Points
•    Yuan Revaluation Set to be Gradual
•    China Accumulation of U.S. Reserves Will Likely Slow

The decision by the PBOC is a reinstatement of the crawling peg which market participants witnessed in 2005 to 2008 where the exchange rate was largely based on market supply and demand regarding a basket of currencies. The expected result for the currency going forward is for the yuan to push higher against the U.S. dollar. However, following the decision, policy makers stated that with the balance of payments (BOP) “moving closer to equilibrium, the basis for large-scale appreciation of the RMB exchange rate does not exist.” Additionally, the central bank reiterated its longstanding policy that the exchange rate would remain “basically stable.” In basic context, the advance in the yuan is expected to be slow and will likely daunt speculative inflows. However, the decision does bode well for the world’s second largest economy.

By allowing the yuan to freely float, the People’s Bank of China is permitting for an adjustment in relative prices. Prior to this weekend’s decision, conditions would have to reach equilibrium by wages and prices. Also, the move is beneficial for China in terms of growing the purchasing power of the nation, while cooling inflation as consumer prices soared an annualized 3.1 percent in May, surpassing economists expectations.  In addition, the decision reduces the probability of an aggressive policy tightening or credit controls. On the other hand, market participants should not overlook the downside effects that Chinese decision will have on U.S. Treasuries. Smaller trade imbalances and a decline in the purchasing flow will basically result in China purchasing less of U.S. Treasuries.

All in all, this move seems to be a politically inspired decision ahead of the G-20 meeting and we can see traders slowly digesting the recent news as the overnight rally in most major currencies against the U.S. dollar is tapering off. Looking ahead, China’s move will surely be a focus at next week’s meeting.




The USD/CNY plunged from a high of 6.8275 to reach a five year low of 6.7962 following China’s decision to unleash the yuan. Traders should caution today’s limit of approximately 0.67930 as the People’s Bank of China stated that the daily band will not widened beyond 0.5 percent.




Prior to this weekend’s announcement, expectations for a yuan appreciation had increased to the highest level since the middle of 2009 as twelve-month forward contracts for Chinese Yuan’s reached approximately 6.80/USD. The rally in forwards served as an indication for an appreciation in the currency over a six month horizon.




The EURUSD rallied overnight to the highest level since May 24th as market participants absorbed China’s move as a sign that policy makers have faith in the global economic recovery, and optimism regarding the European debt crisis. Indeed, the pair is due for a much needed correction, however, we may see traders place the weight back on the euro in the medium term as governments phase out stimulus measures in order to battle ballooning budget. It is worth mentioning that the euro erased its early gains as market participants digest the implications of China’s decision. Nonetheless, Hungary attempted to raise HUF 50 billion of 12 – month bills but came short of that target to raise only HUF 35 million.


Written by Michael Wright, Daily FX Research
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Michael Wright is the author of FX Headlines, Fundamentals vs. Technical's, Weekly Spotlight, and Forex Trading Weekly Forecast