China's Yuan Surges Offshore, With an Apparent Boost From Beijing

By Saumya Vaishampayan Features Dow Jones Newswires

China's currency surged to its highest level against the dollar in six months in offshore markets on Wednesday, a move some traders ascribed to Chinese central bank intervention meant to warn investors off betting against the yuan following Moody's downgrade of Chinese government debt last week.

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The yuan rose as high as 6.7677 to the U.S. dollar in the offshore market, centered in Hong Kong, its strongest intraday level since Nov. 4, according to Wind Info. That marked a gain of 0.8% from its level late Tuesday. The yuan also rose in the tightly controlled onshore market, ending 0.6% higher from its Friday close of 6.8210 to the dollar: The onshore market was closed for national holidays on Monday and Tuesday.

A sharp rise in the cost for banks to borrow the yuan short-term in Hong Kong was a key driver of its surge, traders and analysts said. The overnight yuan borrowing rate soared to 21.08% on Wednesday from 5.35% on Monday, according to the Hong Kong-based Treasury Markets Association.

Traders said the People's Bank of China likely intervened in the offshore market last week, with some state-owned Chinese banks refraining from lending out yuan in Hong Kong, driving borrowing costs higher. The PBOC didn't immediately respond to a request for comment.

Speculation about such intervention swirled again on Wednesday.

Alex Wolf, senior emerging markets economist at Standard Life Investments in Hong Kong, was among those who said the Chinese central bank was probably behind the rise in borrowing costs.

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"There is really no other reason you'd have a spike in yuan-funding costs," he said. "The only way they can really manage the offshore rate is through squeezing liquidity, since it is more market-based."

The cost of borrowing the yuan in Hong Kong has surged periodically over the last 18 months, each time helping to push the yuan up against the dollar. Higher short-term borrowing costs make it more expensive for investors to short, or bet on a decline in, the yuan, which often forces them to buy back yuan and sell dollars as they give up on those bets.

"We're seeing quite a big positioning washout happening" said Khoon Goh, head of Asia research at ANZ in Singapore.

One difference this time is that the yuan has already been appreciating against the dollar, one of many major global currencies that rose against the greenback in recent weeks. The Chinese currency is on track to gain nearly 2% against the dollar in the offshore market this month.

The suspected intervention by the Chinese central bank in recent days comes after ratings firm Moody's Investors Service last week downgraded China's credit rating and warned about the country's high levels of debt.

China has shifted to targeting stability in the yuan against the dollar this year, which had already helped curb investors' expectations for how much the yuan might fall in the coming months. The likely intervention in Hong Kong markets in recent days suggests China still felt the need to deter investors overseas from viewing the Moody's downgrade as a reason to turn bearish.

"It is a bit of an overreaction, but I wouldn't necessarily put it past them," Mr. Wolf said, referring to Chinese authorities.

China's central bank has recently been guiding the yuan to stronger-than-expected levels in the onshore market, another sign that it is seeking to bolster the currency. It has also tweaked the way it calculates its daily fix for the yuan-dollar pair, adding a "countercyclical" component that lets it exert more control over the yuan's value.

Investors appear to be responding to the Chinese central bank. In a shift, those using options are now bracing for further gains in the offshore yuan over the next month.

The one-month risk reversal for the dollar against the yuan turned negative on Friday, which means bearish put options on the dollar against the offshore yuan are now more expensive than bullish call options. Investors would typically buy bearish put options on the currency pair if they expect the dollar to fall against the yuan over a specific period. An options contract grants the right to buy or sell the underlying asset.

That risk reversal is now at its most negative level ever, according to Thomson Reuters data going back to 2013. However, longer-dated risk reversals remain positive, suggesting investors are still bracing for yuan depreciation over the next few months.

"The bias is now shifting to one which is favoring short-term [yuan] appreciation," said Eddie Cheung, Asia currency strategist at Standard Chartered Bank.

Write to Saumya Vaishampayan at saumya.vaishampayan@wsj.com

(END) Dow Jones Newswires

May 31, 2017 07:45 ET (11:45 GMT)