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Rampant dollar threatens to break China’s tight grip on the yuan

Bundles of Chinese yuan banknotes at the Ninja Money Exchange, operated by Interbank HD, in the Shinjuku district of Tokyo, Japan, on Thursday, June 9, 2022. Caught in the crossfire between the two wildly different monetary policy regimes in Tokyo and Washington, at one point Tuesday, the Japanese currency was less than one yen away from its 2002 high of 135.15 per dollar. Photographer: Toru Hanai/Bloomberg
Bundles of Chinese yuan banknotes at the Ninja Money Exchange, operated by Interbank HD, in the Shinjuku district of Tokyo, Japan, on Thursday, June 9, 2022. Caught in the crossfire between the two wildly different monetary policy regimes in Tokyo and Washington, at one point Tuesday, the Japanese currency was less than one yen away from its 2002 high of 135.15 per dollar. Photographer: Toru Hanai/Bloomberg

By Bloomberg News

As the list of central banks intervening to protect their currencies against the surging dollar gets ever longer, one country is notable by its absence: China.

While the People’s Bank of China has plenty of tools it can use to defend its currency, it’s largely sitting on the sidelines despite the yuan’s decline to its weakest levels since the early days of the pandemic. The currency hasn’t been this close to the weak end of the fixing band since 2015.

The official rhetoric right now is all about respecting the market: Wang Chunying, a spokesperson for the State Administration of Foreign Exchange, told state television that short-term fluctuations are hard to forecast. A government-backed newspaper said Friday the yuan was trading within a “reasonable” range.

Yet pressures are building as global risk-off sentiment sweeps the market, due to the Federal Reserve’s battle against inflation and dramatic declines in key trading-partner currencies. The problem is, intervening outright — as the likes of Japan, the Philippines and India have all done — would be a big step for policymakers still bruised by a botched devaluation episode seven years ago. That makes it look like an orderly depreciation may be the best policy makers can hope for.

“You do see a perfect storm emerging,” said Peter Kinsella, global head of FX strategy at Union Bancaire Privee UBP SA in London. “I suspect another 4% move in the next 6 months would not be totally unreasonable.”

The most notable action the PBOC has taken so far is to publish stronger-than-estimated reference rates for the yuan in a record 22-day stretch. The yuan is still a managed currency so the central bank can dictate its direction with the fixing — which restricts movement by 2% on either side — and can drive up the cost of betting against it with derivatives. The PBOC recently slashed the amount of foreign currency banks must hold in reserve, which increases dollar liquidity onshore.

None of these measures has come across as forceful enough to suggest a line in the sand for China. The yuan is down almost 12% against the greenback this year and on track for a seventh straight month of declines — the longest stretch since the height of Trump’s trade war in 2018. It broke past 7-per-dollar earlier this month without much drama, suggesting the historically key number lacks importance for policy makers and traders alike.

“In a strong dollar world, you don’t have many good options for PBOC to blow off steam,” said Leland Miller, co-founder of China Beige Book International, a provider of economic data.

Upping the ante and intervening directly would be a high-stakes decision. Memories are vivid of the devaluation episode seven years ago when it looked like China might get caught in a never-ending spiral of capital outflows and a weakening yuan. An estimated $1.7 trillion left the country in 2015 and 2016. Since then, China has closed some of the leakiest avenues for capital to leave the country while Covid Zero is also helping keep residents and their money onshore.

From a political standpoint, President Xi Jinping has little to gain from doing anything that risks adding drama to Chinese financial markets. His government has made stability a priority ahead of a twice-a-decade party congress in October at which he’s expected to secure a precedent-breaking third term in office.

And in what’s turning into an increasingly extreme risk-off global market environment, China has achieved subtle success in ensuring the yuan’s orderly depreciation against the dollar. There’s no sign of panic: a gauge measuring expected swings in the yuan and an indicator for bearish options are far below their peaks for the year, and never reached the levels seen in the aftermath of Beijing’s shock 2015 move.

“As long as two-way interest in the USD/CNY persists, it gives the PBOC some breathing room,” said Eugenia Fabon Victorino, the head of Asia strategy at SEB AB.

©2022 Bloomberg L.P.