China: Behind CNY’s surprise fall - RBS

Research Team at RBS, suggests that the PBoC has withdrawn its defence of USD/CNY at or below 6.70 after China’s National Holiday as apparently there is no longer a strong case for keeping USD/CNY stable after the G20 summit and the yuan’s SDR inclusion.

Key Quotes

“But NO ‘surprise’ moves on China’s exchange rate regime

The biggest driver of CNY fixing this week is the dollar’s broad based and unabated rally. The PBoC simply allows the dollar’s strength to be reflected, as prescribed by under the current rule of fixing.

Will the PBoC simply let it go?

Contrary to market belief, the PBoC is trying to slow down the rise of USD/CNY in recent days, by setting USD/CNY fixing slightly lower than rule-implied level. Direct evidence is the sharp rebound in CFETS CNY index, indicating CNY has actually not depreciated as much against the dollar as other currencies in CFETS basket.

So far we have seen little sign of panic. Onshore daily trading volume has expanded slightly to $27bn – still far below the previous levels of $40-50bn last August and early this year, and USD/CNY closing price has not jumped up much further than each daily fixing.

That said, developments need to be monitored, as continued new highs in USD/CNY do tend to unsettle market expectations. A self-reinforcing depreciation (i.e. higher fixing price of USD/CNY leads to even higher closing price, which in turn contributes to a higher fixing price next day…) will justify stronger intervention, at the daily fixing or/and closing prices.

A repeat of mid-May and mid-July

In sum, China’s policymakers have continued to balance stability and flexibility under the existing rule of fixing, but tilting towards flexibility as the dollar’s rally sharpens the trade-off.

This is reminiscent of mid-May and mid-July, when a similar rally of the dollar pushed up USD/CNY but supported CFETS CNY index (as the PBoC tried to slow the yuan’s depreciation against the dollar).

Overall, we believe USD/CNY’s break of 6.70 opens the door for further depreciation, though still to be controlled in an orderly and stop-and-go fashion. We maintain our USD/CNY forecast of 6.80 by end-2016 and 7.20 by end 2017.”