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Chinese Yuan Tracks Market Moves More Closely – the New Normal?

Chinese Yuan Tracks Market Moves More Closely – the New Normal?

Renee Mu, Currency Analyst


Fundamental Forecast for the Yuan: Neutral

This week both the offshore Yuan (CNH) and onshore Yuan (CNY) posted its largest weekly decline of the year on strong US Dollar gains. The PBOC weakened Yuan’s daily reference rate by a total of 595 pips over the past week to guide the currency move along with the market trend. Looking into next week, China will release key manufacturing figures and its counterparty US will publish a series of major reports including non-farm payrolls (NFP) and unemployment rate. Event risks will be the main driver for the Dollar/Yuan pairs.

Yuan’s drop this week was in line with other major currencies’ weakness against the US Dollar. It reflects China’s Central Bank’s target: to let the Yuan stable relative to a basket of currencies. Also, yuan’s daily reference rate set by the Central Bank has seen increased volatility lately. Following three instances that the daily fixing moved up more than 200 pips last week, the rate dropped more than 200 pips on Thursday. Such large moves were seldom seen over the past seven months since the de-pegging against the Dollar. The daily move in the reference rate has increased from an average of 25 pips before the de-pegging to 66 pips after the de-pegging and to 170 pips over the past 10 days. Despite PBOC remains the trading band for the onshore Yuan at 2% around the reference rate, it gave more flexibility to the reference rate and let it be more market-driven.

The coming week will be a good illustration of the flexibility in Yuan’s reference rate: to see if the increased market role in Yuan is temporary or is likely to last longer. China’s most important counterparties, US, will issue a couple of major reports including consumer confidence, NPF and unemployment rate reports, which certainly will impact the Dollar pairs, including the more market-driven offshore USD/CNH pair (compared to onshore). If the daily reference rate on the following day moves consistently with the offshore rate in previous day, it then adds evidences to a persistent increased market role in Yuan’s managed floating regime.

In addition, China will release PMI reports for March. With the ongoing production cuts in the manufacturing firms led by the government, the manufacturing industries are likely to continue to show weakness. In a longer-term, they may benefit from the fiscal stimulus announced at the NPC meeting: the country will adopt an aggressive fiscal policy with a target fiscal deficit at 3%, the highest the level since the country was set up in 1949. However, it will take a while for the policy to take into effect, so we may still see contraction in manufacturing sectors in March; improved performance in later months. Until then, the manufacturing sectors won’t provide much support to the Yuan. -RM

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.