Yuan Fix faces 6.9 per dollar test after FX reserve ratio cut

(Bloomberg) – China pegged a stronger-than-expected exchange rate for a 10th straight day and said it would allow banks to hold less foreign currency in reserve, its most significant move yet to stabilize a weakening yuan.

The People’s Bank of China set the benchmark yuan rate at 6.9096 to the dollar on Tuesday, trailing the currency’s move to its lowest level in two years. It came a day after the central bank said financial institutions will only have to hold 6% of their currencies in reserve from September 15, increasing the supply of dollars and other currencies onshore. The 2 percentage point drop is largest in data dating back to 2004.

While the moves should limit the yuan’s declines against the greenback, they don’t suggest the central bank is trying to reverse the losses. Authorities may want to slow the pace of depreciation, but they are “not drawing a line in the sand to maintain any particular level just yet,” said Khoon Goh, head of Asia research at Australia. & New Zealand Banking Group.

The question is whether there will be firmer action from authorities if the yuan begins to approach the psychological level of 7 per dollar, he said.

Betting against the yuan has been a successful strategy over the past month. The yuan plunged 2.5% as China’s Covid-Zero strategy hurt an already fragile economy and aggressive U.S. rate hikes accelerate capital outflows. The writedown comes at a sensitive time for Beijing, which is preparing for a twice-a-decade party reshuffle next month. This is why it is paramount for the authorities to maintain stability in the foreign exchange market, as a disorderly fall in the yuan could spill over into equities and endanger financial stability.

The PBOC has intensified its efforts to stem the depreciation of the yuan over the past two weeks. Stronger-than-expected fixations for 10 straight sessions mark the longest streak of strong biases since 2019. Monday’s cut in the FX deposit rate was twice as large as April’s cut. Also on Monday, PBOC Deputy Governor Liu Guoqiang told reporters in Beijing that China was able to keep the yuan stable, adding that would be a short-term “norm” for the Chinese currency. to evolve in two ways.

Do not panic

Tuesday’s fixing marks the first time in two years that it broke through the crucial 6.90 level, the last major barrier before the yuan breaks the key 7 mark. In 2019, when the PBOC allowed the rate to benchmark to exceed it, the offshore yuan fell. 1.8% in a single day.

The central bank’s decision caused little stir this time around, with the yuan losing less than 0.1% against the greenback, both onshore and offshore. On a trade-weighted basis, a real-time Bloomberg replica of the CFETS RMB Index fell 0.2%.

Signaling a lack of panic, the bearish sentiment towards the Chinese currency, as evidenced by the sensitive options market, has faded. The one-month option premium to hedge the dollar-yuan’s rise against its decline has fallen over the past two weeks and hit its lowest level since July 12 on Tuesday.

Analysts say they expect the PBOC to take more action if the yuan’s depreciation gathers pace again, particularly if it triggers a herd mentality among traders. Nomura Holdings Inc. expects the central bank to cut the foreign exchange reserve ratio by another 100 basis points by the end of this year, while United Overseas Bank Ltd. said the PBOC could also increase offshore bond issuance to soak up cash.

Although weak fundamentals may weigh on the yuan for some time, the market should keep in mind that the PBOC is “well equipped” to handle the currency, according to Ming Ming, chief economist at Citic Securities Co.

Read more: From fixing to signaling, how China manages the yuan: QuickTake

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Sallie R. Loera