The Chinese yuan gains seen this week, coupled with the Russia/Ukraine turnabout, have gone a long way to allay market fears about pending doom and gloom, analysts said.
After falling Monday, global stocks rebounded solidly Tuesday and U.S. Treasury and German Bund yields firmed as safe-haven positions were unwound, they noted.
In the case of the up-until-recently depreciating yuan, analysts could not yet say that the worst was over and they urged caution.
The People’s Bank of China earlier set the yuan central parity rate versus the dollar lower at CNY6.1236. This compared to the CNY6.1190 seen Monday and the record yuan high of CNY6.0930, set Jan 14.
In contrast, in the on-shore market, the Chinese yuan ended at CNY6.1430 versus the dollar, with the yuan firmer than at Monday’s close of CNY6.1462.
Dollar-yuan (on-shore) peaked at CNY6.1760 Friday, the highest level seen since April 25, 2013.
Relative yuan stability, seen over the course of this week, has helped to underpin risk sentiment, analysts said.
Bob Sinche, global strategist at Pierpont Securities, discouraged investors from putting on long CNY exposure into the National People’s Conference that begins Wednesday.
Those who see yuan appreciation as a one-way street may be disappointed if the PBOC, a “monopolist” (who “can control quantity or price but not both),” decides to “keep the CNY weak and allow the quantity of CNY reserves to remain ‘demand determined,” instead of letting the CNY appreciate “to gain control over bank liquidity and borrowing costs,” he said.
“Even a monopolist cannot have both!” Sinche said, “With the economy soft and inflation at 2.5%, below the soft target of 3.5 – 4.0%, it appears likely the PBOC will continue to keep the CNY soft and allowing borrowing costs to hold at lower levels, at least as long as short-term rates remain comfortably above inflation.”
This week, PPBC Governor Zhou Ziaochuan was quoted as saying that recent movements in the yuan exchange rate are “normal,” which backed up current market thinking that perhaps the central bank is allowing more two-way risk.
“Nothing happens in the yuan market unless the PBOC wants it to happen,” said Carl Weinberg, chief global economist at High Frequency Economics in Valhalla, NY.
One “commonly posited theory” about the recent weakness in the yuan is that the PBOC is set to widening the daily trading band to 1.0% from 0.5% ahead of the NPC, he said.
“Let us suppose this is true,” Weinberg said, “Why would widening the daily trading band make the yuan depreciate?”
“If anything, we would expect a wider band for the yuan to invite more people into the market to speculate on the tiny intraday price action in the currency; that would push up the demand for the yuan, not crimp it,” he said.
One other theory is that the PBOC has used a weakening yuan to send a message to the Federal Reserve about the spillover effects of tapering its asset purchases, he said.
“While tapering is not tightening, it has pushed up U.S. interest rates and it may crimp capital flows to countries like China and its emerging market allies – perhaps China wants the Fed to understand what a world without an appreciating yuan looks like,” Weinberg said.
Overnight Tuesday, China’s 28-day repo rate was pushed up to 4.0% from 2.5%, with market talk that the PBOC was trying to sop up the excess liquidity seen in the banking system after the Lunar New Year holiday, he said.
“Higher short-term interest rates will give the entire yield curve a lift, and that may be part of the central bank’s efforts to support the yuan,” Weinberg said.
Traders were spooked earlier by the 28-day repos that the PBOC used to drain CNY50 billion during the morning’s open market operations.
Although the bank is yet to reintroduce three-month sterilization bills to drain liquidity, the extension out to 28 days from the 14-day instruments that the authorities have been relying on was enough to sharpen nerves about funding availability in the weeks ahead.
Nonetheless, the seven-day rate (lat traded at 3.5100%) remains below the 4% level cited by a PBOC official in dovish comments to state media last week. The overnight rate was last at 2.0800%, up only slightly on late Monday’s to 2.0682% average and near the sub-2% level cited by the PBOC official.
Credit Suisse analyst Dong Tao maintained that the BPOC actions, allowing the yuan to depreciate versus the dollar since mid February, were indeed done to introduce two-way risk to the foreign exchange market.
“The PBOC has had great success in teaching speculators a lesson,” although the steepness of the yuan slide “probably exceeded the central bank’s expectation,” he said in a note.
Credit Suisse does not look for the CNY depreciation currently underway “to last long, because Beijing cannot afford to see the appreciation expectation turn around, which could trigger a strong capital flight.”
Tao looked for further two-way volatility going forward, but thought that the central bank “will stay on the track of mild appreciation against the dollar.”
“We do not expect the weakening in the exchange rates to trigger a crisis, but we are concerned about credit risks as trust funds are about to enter the repayment peak season,” he said.
In addition, “Beijing’s frequent attempts to ‘teach lessons'” to the market, are “cause for concern regarding policy mistakes,” Tao said.
The National People’s Congress will begin Wednesday, with the market homing in on Premier Li Keqiang’s opening address, due around 0900 local/0100 GMT for clues about the policy direction for 2014.