China's Daily Yuan Fix Makes Biggest Leap in Five Months

By Saumya Vaishampayan and Shen Hong Features Dow Jones Newswires

China's central bank guided the yuan to its biggest one-day jump in roughly five months Thursday, the latest sign that authorities are seeking to bolster the yuan in the wake of the downgrade of the country's sovereign debt by Moody's Investors Service last week.

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The yuan fix was 0.8% stronger than Wednesday's, as China set the dollar's daily midpoint for trading at 6.8090 yuan, compared with 6.8633 yuan. It was the yuan's highest level since Nov. 10. The jump wasn't entirely surprising, traders said: The yuan ended onshore trading Wednesday at 6.8210 to the dollar, its strongest point since Nov. 11, after a 0.6% surge that day.

Commerzbank's model had predicted the fix would set the dollar at 6.8136 yuan, while a Shanghai-based senior trader with a domestic bank said his own model expected a fix of about 6.8100.

In setting the daily fix, the People's Bank of China considers where the yuan ended against the dollar in the previous day's onshore trading, the overnight movement of a basket of currencies and a "countercyclical" factor that was unveiled last week. Within China, the yuan trades in a tight band around that fix. In theory, it trades freely offshore, in major hubs like Hong Kong.

The central bank has intervened in the onshore market in recent days, traders say, directing state-owned banks to buy yuan and sell dollars. Without that, the yuan wouldn't have become so strong, said the Shanghai-based trader.

"The key question for everyone now is when the PBOC will let this round of appreciation end," the trader said. "These are quite uncertain times for yuan traders."

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Analysts say the PBOC's propping up the yuan could be meant to deter investors from betting the yuan will decline following the Moody's downgrade of China's sovereign debt. Or it could be to help make China's domestic bonds more attractive to foreign investors: The central bank has approved a bond-connect program between the mainland and Hong Kong.

In the offshore market, the yuan advanced 0.2% to 6.7309 against the dollar in the offshore market on Thursday, following a sharp rise the day before. Market participants say the Chinese central bank has likely been behind a surge in short-term borrowing costs for the yuan in Hong Kong, which has pushed the yuan sharply higher in recent days.

The cost for banks to borrow yuan from each other overnight in Hong Kong rose to 42.82% on Thursday from 21.08% on Wednesday. The Chinese authorities have pushed up these rates in the past 18 months to squeeze investors out of bearish bets on the yuan, analysts say.

While investors in the options markets are now paying up for contracts that protect against a rise in the offshore yuan in the next month, they still expect a decline over the longer run.

"With the cyclical peak in growth in the rear mirror, it is just a matter of time until the authorities need to get back to facilitating depreciation in the trade weighted currency," Jason Daw, head of emerging markets foreign exchange strategy at Société Générale, wrote in a note.

Write to Saumya Vaishampayan at saumya.vaishampayan@wsj.com and Shen Hong at hong.shen@wsj.com

Corrections & Amplifications

This was corrected at 7:32 a.m. ET because the original incorrectly stated it was to deter bets against the yen in the seventh paragraph.

Analysts say the PBOC's propping up the yuan could be meant to deter investors from betting the yuan will decline following the Moody's downgrade of China's sovereign debt. "China's Daily Yuan Fix Makes Biggest Leap in Five Months," at 00:16 ET, incorrectly stated it was to deter bets against the yen in the seventh paragraph. (June 1, 2017)

China's central bank guided the yuan to its biggest one-day jump in roughly five months Thursday, the latest sign that authorities are seeking to bolster the currency in the wake of the downgrade of the country's sovereign debt by Moody's Investors Service last week.

The People's Bank of China set the dollar's daily midpoint for trading at 6.8090 yuan, meaning the yuan was at its strongest since Nov. 10. This strong "fix," which takes into account where the yuan finished trading the day before, came after the currency surged against the dollar in onshore trading Wednesday.

The yuan rose even higher after trading began at 9:30 a.m. local time Thursday. That is a change from recent weeks, when the central bank guided the yuan to stronger-than-expected levels, only to watch it weaken once trading began.

Shifting expectations about the yuan's short-term fortunes are driving the change.

The central bank tweaked the mechanism for setting the daily fix last Friday, in effect taking even more control over the value of the yuan--which has helped persuade investors that it is committed for now to strengthening the currency. The new method could also help smooth swings against the dollar. As a result, many analysts have revised their forecasts for the yuan, and now project a smaller decline or even a slight gain for this year.

"What the PBOC is telling investors is that the [yuan] can appreciate against the U.S. dollar," said Larry Hu, China economist at Macquarie.

The central bank has been intervening in the onshore market in recent days, traders say, directing state-owned banks to buy yuan and sell dollars to prop up the currency. Without that intervention, the yuan wouldn't have become so strong, said a Shanghai-based senior trader with a domestic bank.

"The key question for everyone now is when the PBOC will let this round of appreciation end," the trader said. "These are quite uncertain times for yuan traders."

Soaring borrowing costs for the yuan in Hong Kong have also propelled the Chinese currency higher outside of China, where it trades more freely. That overnight yuan borrowing rate hit 42.82% on Thursday, up from 21.08% on Wednesday. The offshore yuan rose as much as 0.3% from its level late Wednesday before giving up its gain; it was recently down 0.2% at 6.7591 to the dollar.

There are several theories as to why Beijing is allowing the yuan to strengthen so much right now.

Some analysts and traders say the central bank could be pre-emptively warning investors off betting against the yuan in an effort to keep the currency stable. While the Moody's downgrade on May 24 didn't reveal any new fragilities in China's economy, it highlighted the risks associated with the rapid debt buildup that is fueling recent growth.

Another theory is that China's central bank is taking the opportunity afforded by the dollar's weakness against several currencies to strengthen the yuan. That should provide more leeway to allow weakening against the dollar later this year if the economy cools or the U.S. central bank raises interest rates further.

Allowing the yuan to rise more against the dollar could also be a way to stem its fall against trading partners' currencies. The yuan had already been rising against the dollar before its recent dramatic moves, but the Korean won and Mexican peso were rising faster. An index of the yuan's value against a basket of currencies fell Friday to its lowest level since it was first published by the central bank in 2015.

Or it could be to help make China's domestic bonds more attractive to foreign investors, since the central bank has approved a bond-connect program between the mainland and Hong Kong. China has been trying to attract foreign money into its domestic markets; net capital outflows rose to more than $20 billion in April, according to the Institute of International Finance.

"Nobody wants to invest in a country when you expect the currency to fall," said Mirza Baig, head of foreign-exchange and interest-rate strategy for Asia at BNP Paribas in Singapore.

Shen Hong and Lingling Wei contributed to this article.

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

(END) Dow Jones Newswires

June 01, 2017 08:16 ET (12:16 GMT)