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Yuan Likely Stable to Prepare for a Smooth SDR Entry

Yuan Likely Stable to Prepare for a Smooth SDR Entry

2016-09-23 23:29:00
Renee Mu, Currency Analyst
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Yuan Likely Stable to Prepare for a Smooth SDR Entry

Fundamental Forecast for the Yuan: Neutral

The Chinese Yuan will officially join the SDR basket as the fifth reserve currency on October 1st. This will likely be the dominant theme for all Yuan pairs in the coming week. An unchanged interest rate released by the U.S. Federal reserve this past week provides a less volatile environment for the Dollar/Yuan before Yuan’s official inclusion. Both the offshore Yuan (USD/CNH) and onshore Yuan (USD/CNY) failed to break out major levels and remain below the key resistance of 6.70, due to a lack of sufficient Dollar strength. After all the Fed and Bank of Japan headlines, traders will want to shift attention to China: the Chinese currency will prepare for the SDR entry; volatility in Yuan’s onshore and offshore borrowing rates may increase once again ahead of one of the most important Chinese holidays - the National Day; and China will release key manufacturing prints for the month of September.

Main focuses for Yuan pairs are shifting back home. Over the past week, we have already seen major developments added to the momentum of Yuan’s rise as a global currency. China’s Central Bank designated Bank of China’s New York branch as Yuan’s clearing bank in the U.S. on September 21st and picked Industrial and Commercial Bank of China’s Moscow branch as Yuan’s clearing bank in Russia on September 23rd. The PBOC also approved the Yuan’s directly trading with Saudia Riyal and United Arab Emirates Dirham in China’s interbank market effective on September 26th. The Central Bank signed bilateral currency swap deal with Hungarian Central Bank and issued membership to four other central banks allowing them to trade in China’s interbank FX market. Amid these latest moves to accommodate the Yuan as a global currency, Yuan rates are likely to stay stable as well. The major threat to dramatic moves in Yuan’s major counterpart, the U.S. Dollar, has been curbed in the short-term following a flat interest rate from the Fed. The next release of the FOMC minutes will be on November 2nd, which leaves a window for the Yuan to make a smooth transition for the SDR inclusion.

Unusual surges in the funding cost of the offshore Yuan may emerge again, as what was seen around the 3-day national holiday a week ago. HIBOR O/N, the overnight Yuan borrowing rate in Hong Kong began to pick up ahead of the holiday last week and jumped to the second highest level on record after markets reopened. It is not uncommon that Yuan liquidity tightens ahead of a major holiday but the condition normally eases after the holiday; such high levels are rare as well. Therefore, markets have been growing increasingly skeptical that China’s Central Bank was intervening the market, aiming to squeeze out Yuan shorts.

The onshore Yuan borrowing rate was in an uptrend as well: the borrowing cost of the Yuan in Shanghai interbank market (SHIBOR) increased for 13th consecutive days until September 22nd. Looking forward, China’s onshore markets will close from October 1st to 7th for the National Day celebration, when no Yuan reference rate will be issued by the PBOC. This increases the likelihood that the regulator may use other tools to guide markets, especially during the critical transition period for Yuan’s SDR inclusion. Traders will want to keep a close eye on HIBOR, SHIBOR and Yuan fix next week to find out clues on the PBOC’s intention. If tightened Yuan liquidity is seen again, no matter driven by holiday shutdown or regulator’s intervention, the Dollar/Yuan rate may drop further as Yuan’s borrowing cost increases.

Last but not least, China will release official and Caixin Manufacturing PMI prints, key measures for the health of the economy and drivers for Yuan’s intraday moves. The August and July PMI reads sent out mixed signals: In August, the official PMI read showed contraction while Caixin PMI indicated expansion; in July, Caixin PMI read dropped while the official print rose. The September prints may give out more clues on what is really going on in the Chinese manufacturing sector. The major issue that Chinese manufacturing firms are facing is low demand and overcapacity. According to a survey conducted by Bloomberg, the consensus forecast for the official PMI is 50.5 and for the Caixin PMI is 50.1, both in expansion territory. If the PMI prints come out weaker-than-expected, the Yuan could weaken against the U.S. Dollar during the session, though it is very unlikely to break the key level of 6.70 with Yuan’s SDR inclusion on the horizon.

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