In the aftermath in the recent surge in China’s renminbi volatility which saw it plunge at the fastest pace in years, many, us included, suggested that the immediate next step in China’s “fight with speculators” (not to mention the second biggest trade deficit in history), was for the PBOC to promptly widen the Yuan trading band, something it hasn’t done since April 2012, with the stated objective of further liberalizing its monetary system and bringing the currency that much closer to being freely traded and market-set. Overnight it did just that, when it announced it would widen the Yuan’s trading band against the dollar from 1% to 2%.
The healthy development of China’s current foreign exchange market, trading body independent pricing and risk management capabilities continue to increase. To meet the requirements of market development, increase the intensity of market-determined exchange rate, and establish a market-based, managed floating exchange rate system, the People’s Bank of China decided to expand the foreign exchange market, the floating range of the RMB against the U.S. dollar, is now on the relevant matters are announced as follows:
Since March 17, 2014, inter-bank spot foreign exchange market trading price of the RMB against the U.S. dollar floating rate of expansion from 1% to 2%, or a daily inter-bank spot foreign exchange market trading price of the RMB against the U.S. dollar foreign exchange transactions in China can be Center announced the same day the central parity of RMB against the U.S. dollar and down 2% in the amplitude fluctuations. Designated foreign exchange banks to provide customers with the highest cash offer price of $ day of the minimum cash purchase price difference does not exceed the magnitude of the day the central parity rate expanded from 2% to 3%, other provisions remain in compliance, “the People’s Bank of China on the interbank foreign exchange market Trading foreign exchange designated banks listed on the exchange rate and the exchange rate management issues related to notice “(Yin Fa  No. 325) execution.
People’s Bank of China will continue to improve the RMB exchange rate formation mechanism of the market, further develop the role of the market in the RMB exchange rate formation mechanism, strengthen two-way floating RMB exchange rate flexibility, to maintain the RMB exchange rate basically stable at an adaptive and equilibrium level.
Amusingly, we may have the first attempt at forward guidance by yet another central bank: that of China. As the WSJ explains: “There is no basis for big appreciation of the renminbi,” the PBOC said, noting that China’s trade surplus now represents only 2.1% of its gross domestic product. At the same time, “there is no basis for big depreciation of renminbi,” the central bank added, saying that risks in China’s financial system are “under control” and the country’s big foreign-exchange reserves can serve as a big buffer against any external shocks.
Alas, in China merely soothing words hardly ever do the job which is why “while pledging to give the market a bigger role in setting the yuan’s exchange rate, the PBOC said it would still implement “necessary adjustments” to prevent big, abnormal fluctuations in the yuan’s exchange rate.”
The macro thinking behind China’s move was foretold well in advance, but for those who missed it, the WSJ does a good recap:
the change, which followed Beijing’s landmark move in 2012 to double the yuan’s trading bandwidth, is seen as an important step toward establishing a market-based exchange-rate system, whereby the yuan would move up and down just like any other major currency.
The exchange-rate reform is part of China’s plan to overhaul its creaky financial sector, elevate the country’s status in the international monetary system and someday challenge the U.S. dollar as the de facto global currency.
A freer yuan can also help China deflect foreign complaints about its currency policies. The U.S. and other advanced economies have pressed Beijing for years to relax its hold on the yuan and allow it to appreciate at a faster pace. The hope is to boost consumer demand in China as consumers in Western countries such as the U.S. and Europe pull back amid still-fragile economies.
The move to widen the yuan’s trading range comes as China’s juggernaut economic machine is slowing down, leading to questions of whether leaders would continue to press ahead on fundamental economic change, or pull back to help struggling companies.
For some even the doubling in the rate band is not enough:
Widening the band would give a greater indication of how the market values the yuan. A prominent Chinese economist, Yu Yongding, for instance, advocates that the daily band be widened to 7.5% in either direction, which would essentially let the market fully determine the rate.
But perhaps the biggest message from today’s announcement is that China is preparing to focus far more on its internal affairs rather than dealing with daily FX manipulation, as well as the micromanagement of China’s reserves, which recently may or may not have been sod off in the form of US Treasurys.
Meanwhile, loosening its hold on the yuan can also help the PBOC focus more on domestic monetary policy while reducing the need for currency intervention by the central bank.
That is because when the yuan’s floating range gets bigger, the yuan won’t touch the upper or lower limit of the band as frequently as it did in the past, thereby making it less necessary for the PBOC to meddle in the currency market in a bid to rein in or prop up the yuan’s value.
As a result, with the expanded trading band, the PBOC is expected to issue fewer yuan for the purpose of exchange-rate intervention, and that could leave the central bank with more room to manage the domestic monetary policy.
“The PBOC will still resort to intervention, but a wider trading band means that it may not need to intervene as readily as it did in the past,” said Christy Tan, a currency specialist at Bank of America Merrill Lynch.
One thing is certain: as the world digests the latest out of the country that creates credit at a pace that is five times greater than the US, the volatility in the CNY will soar, at jthe worst possible time. Because as we explained before, all global specs, especially those out of Hong Kong need, is for the USDCNY to surge above 6.20 for the margin calls to start coming in fast and furious.
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This latest move by the PBOC is merely the latest step in nearly two decades of Chinese currency liberalization. A brief timeline of developments is shown below, courtesy of Bloomberg:
- January 1994: China unifies official, market exchange rates
- July 2005: China dismantles decade-long peg, allowing yuan to fluctuate against basket of currencies
- May 2007: PBOC widens trading band to allow currency to move 0.5% on either side of daily fixing, up from 0.3%
- April 2012: Yuan band widened to 1%
- November 2013: Daily trading range will be widened in “orderly way,” PBOC Governor Zhou Xiaochuan says in article; China’s leaders vowed at Communist Party summit to give markets a “decisive” role in pricing of resources, with acceleration of yuan convertibility among key proposals
- February 2014: PBOC includes “orderly” expansion of trading band among 2014 policy goals; will continue to broaden cross-border usage
- March 2014: Yuan band doubled to 2% from 1%
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Finally, here are some kneejerk reactions by Wall Street analysts, via Bloomberg.
- The action, coupled with more two- way volatility, could help discourage “hot money” inflows and encourage companies and banks to be more vigilant about exchange-rate risks, Wang Tao, chief China economist at UBS AG in Hong Kong, says in an e-mail.
- Action doesn’t have direct implications for direction of CNY against USD
- UBS still sees exchange rate “broadly unchanged, with increased two-way volatility”
- Action isn’t surprising because central bank has said for a qhile that it would widen band soon: Wang
- “We do not think the PBOC took this move to accelerate the CNY depreciation for mercantile interests to stabilize growth,” Morgan Stanley economist Helen Qiao says in e-mailed comment.
- Wider yuan band will help deter “carry trade speculators” as volatility increases
- Action is “largely in line with our expectation, as a major step in China’s FX reform” and is part of government’s “continued reform efforts”
- Recent CNY depreciation created precondition for band widening
Commonwealth Bank of Australia
- With PBOC dollar purchases being key driver in recent yuan weakness, it will be challenging for yuan to trade at both sides of the doubled trading band in a symmetric fashion, Andy Ji, FX strategist at Commonwealth Bank of Australia, says in email interview.
- Yuan is unlikely to depreciate substantially without PBOC intervention, given the status of current account surplus and without broad dollar strength
- Yuan may weaken in 1H then strengthen in 2H, similar to the patterns in past two years
- PBOC is likely to guide a weaker yuan through its daily reference rate to ensure there won’t be renewed one-way appreciation bets after doubling the trading band, Bank of East Asia FX analyst Kenix Lai says in phone interview today.
- Yuan band widening announcement shouldn’t be too surprising to market given the PBOC has already signaled such a move in Feb.
- Yuan should still be able to deliver mild appreciation in 2014 as China continues to push for yuan internationalization
Bank of America
- Weaker yuan fixings in past month or so has changed one-way appreciation bias, Albert Leung, BofAML local market strategist for Asia, says in email interview.
- PBOC wants to widen band when market view is more balanced
- Not very surprising in terms of band-widening timing
- Another band widening this year is unlikely
- Knee-jerk market reaction should be higher volatility, with higher NDF, DF implied rates
- Long-dated NDFs could weaken further, though not necessarily the daily official fixings
- Any follow-through after the knee-jerk and whether yuan will weaken further will highly depend on PBOC daily fixing and how macro data and corporate credit situation
- With the band widening and, more importantly, recent spate of weak China data, the bias is for near-term yuan weakness and potentially higher volatility, ANZ FX strategist Irene Cheung says in email interview today.
- Yuan band widening didn’t come as a surprise
- Band widening doesn’t necessarily relate to recent PBOC Governor Zhou Xiaochuan’s statement on interest rate liberalization
- Another widening won’t come so soon given the last move was 2 yrs ago in 2012