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Yuan Drops Most on Record Amid Band Widening Speculation

China Yuan Set for Worst Month in 20 Years on Band-Widening Bets
An employee counts Chinese one-hundred yuan banknotes next to stacked Chinese one-hundred yuan banknotes for a photograph at the Korea Exchange Bank headquarters in Seoul, South Korea. Photographer: SeongJoon Cho/Bloomberg

China’s yuan tumbled by the most on record on speculation the central bank will widen the currency’s trading band, allowing greater volatility at a time when growth is slowing in the world’s second-largest economy.

The yuan slid as much as 0.9 percent to a 10-month low of 6.1815 per dollar, the largest decline since China unified official and market exchange rates in 1994, according to data compiled by Bloomberg. The currency lost 1.3 percent in February, the biggest monthly drop on record. Trading in yuan options surged in New York, making them the most traded contracts among major currencies.

The People’s Bank of China is expected to double the yuan’s trading band by the end of June, according to the majority of 29 analysts surveyed by Bloomberg, as policy makers loosen exchange-rate controls and promote greater usage of the currency in global trade and finance. Lawmakers will meet next week to decide on major economic policies and an official report tomorrow is forecast to show manufacturing expanded this month at the slowest pace since June.

“China looks determined to proceed with financial reforms, and so a wider band in the near term looks likely,” said Daniel Chan, a Hong Kong-based strategist at China Silver Global Investment Consultant Ltd. “As yuan selling pressure is still on, a wider band will mean further declines. That’s obviously among the concerns in the market.”

Options Trading

The yuan ended the day in Shanghai down 0.3 percent to 6.1452 per dollar even as the central bank kept its daily reference rate steady to 6.1214 per dollar, Bloomberg data show. The currency is allowed to up to 1 percent on either side of the central bank’s reference rate. The market rate was 0.4 percent below the official quote, the biggest discount since August 2012.

More than $14 billion of dollar-yuan options changed hands as of 11:58 a.m. in New York, accounting for 31 percent of all option trading among major currencies, according to data reported by U.S. banks to the Depository Trust Clearing Corp. The volume reached $31 billion on Feb. 21, compared with a three-month average of $8 billion.

Goldman Sachs Group Inc. said a combination of macroeconomic and currency reform objectives are behind the yuan’s sudden drop, according to a report published yesterday by analysts including Kamakshya Trivedi in New York. There are growing concerns over the growth impact of a credit buildup in the last few years, the report said. Policy makers also want to discourage leveraged bets on yuan appreciation, especially by local companies, it said.

PBOC ‘Engineering’

“There are sound reasons why local policy makers would welcome the kind of depreciation and volatility we have just seen,” the analysts wrote. “To the extent that policy makers care to discourage such carry trade activities -- particularly for local entities -- introducing volatility in the currency is the obvious way of shaking investors out of such carry exposures,” they said.

The PBOC is “engineering” the yuan’s slide to deter bets on one-way appreciation, said Liu Dongliang, a Shenzhen-based senior analyst at China Merchants Bank Co.

The yuan has declined 1.7 percent from the 20-year high of 6.0406 reached on Jan. 14, according to the China Foreign Exchange Trade System prices. It is still up 34 percent since a dollar peg ended in July 2005, the most among 24 emerging-market currencies tracked by Bloomberg.

In offshore trading in Hong Kong, the yuan fell 0.22 percent today to 6.1199 per dollar, after touching a six-month low of 6.1336 earlier. It’s slumped 1.4 percent this month, the most since September 2011.

Twelve-month non-deliverable forwards, which traders use to speculate on the yuan, fell 0.1 percent to 6.1565 per dollar in New York, according to data compiled by Bloomberg. The contacts suggest traders expect the central bank’s reference rate may fall about 0.6 percent in one year.

The median estimate of analysts surveyed by Bloomberg was for the rise to gain 2.9 percent to 5.97 per dollar by the end of 2014.

‘Severity of Moves’

“The severity of moves is surprising the market,” said Khoon Goh, a Singapore-based strategist at Australia & New Zealand Banking Group Ltd. “There are not many dollar offers and any bid is just getting taken, driving the dollar higher against the yuan.”

The PBOC included an “orderly” broadening of the yuan’s band among its 2014 policy goals in a Feb. 19 statement, while the State Administration of Foreign Exchange said on Feb. 26 that two-way moves in the exchange rate will be the norm and that the market shouldn’t read too much into the recent decline.

Of 29 analysts surveyed by Bloomberg News in the past week, 20 forecast a band widening in the April-June period, while four said they expected a change in March. The maximum divergence from the PBOC’s fixing will double to 2 percent in the next revision, according to 21 of the predictions.

Weakening Bias

The onshore spot rate was 0.97 percent stronger than the fixing on Jan. 23, before the two converged this week for the first time since September 2012. The yuan was at a 0.24 percent discount to the fixing a day before the last widening of the band, when the maximum allowed divergence was doubled from 0.5 percent. The trading limit was first raised from 0.3 percent in May 2007.

The yuan’s drop “has likely been caused by markets interpreting PBOC bias as being toward testing the lower half of the daily trading band and by speculation that the range may be widened this weekend ahead of the National People’s Congress next week,” said Dariusz Kowalczyk, Hong Kong-based strategist at Credit Agricole CIB.

Implied Volatility

China’s official Purchasing Managers’ Index was probably 50.1 in February, above the 50 mark that divides expansion and contraction, according to the median estimate in a Bloomberg survey before data due tomorrow. That would indicate the slowest manufacturing growth since June. A preliminary reading of PMI by HSBC and Markit Economics released Feb. 20 fell to a seven-month low of 48.3, suggesting a contraction.

Three-month implied volatility in the onshore yuan, a measure of expected moves used to price options, slipped to 2.06 percent today, from a seven-month high of 2.12 percent yesterday, according to data compiled by Bloomberg.

Increased two-way volatility in the yuan is among the key steps needed to prepare for a broader trading band, according to Sacha Tihanyi, a Hong Kong-based strategist at Scotiabank.

“The weakness is policy driven,” said Ju Wang, a Hong Kong-based currency strategist at HSBC Holdings Plc. “The problem is that the market is still rather bullish on the yuan even after a recent selloff. Policy makers want to test the market further and see visible evidence that speculation has reduced.”

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