Yuan Tumbles to 11-Month Low as Band Widening Spurs Volatility

Chinese One-hundred Yuan Banknotes
Chinese one-hundred yuan banknotes are arranged for a photograph. The onshore yuan is allowed, from today, to trade as much as 2 percent on either side of the reference rate, the People’s Bank of China said in a March 15 statement. Photographer: SeongJoon Cho/Bloomberg

The yuan sank to an 11-month low and options traders turned more bearish on the currency as China’s central bank doubled trading limits versus the dollar.

The onshore spot rate slid 0.45 percent to close at 6.1781 per dollar in Shanghai, China Foreign Exchange Trade System prices show. It slid as much as 0.51 percent to 6.1818, the weakest since April 2013. One-year options granting the right to sell the yuan cost 1.83 percentage points more than contracts allowing purchases as of 4:33 p.m. in Hong Kong, the biggest premium in six months, according to data compiled by Bloomberg.

The yuan is allowed, from today, to trade as much as 2 percent on either side of a daily reference rate set by the People’s Bank of China, compared with a previous limit of 1 percent. The decision to allow greater exchange-rate fluctuations comes at a time when China’s economy shows signs of losing momentum, with the government targeting a 7.5 percent growth rate that would be the slowest since 1990.

“Volatility definitely spiked on a wider band while market sentiment is still leaning toward a weaker exchange rate on domestic financial risks and economic data,” said Nathan Chow, Hong Kong-based economist at DBS Group Holdings Ltd.

Widely Expected

The broadening of the trading band was announced on March 15 and came after Premier Li Keqiang and the central bank both named such a change among their 2014 policy goals, which included pledges to give market forces a bigger role in the world’s second-largest economy. Of 29 analysts surveyed last month by Bloomberg, 24 predicted a widening by the end of June and 21 said they expected a change would double the yuan’s trading limits.

The yuan was 0.7 percent weaker than the central bank’s fixing in Shanghai, the biggest discount since July 2012. The PBOC strengthened the reference rate by 0.04 percent to 6.1321.

One-month implied volatility, which is used to price options, fell nine basis points, or 0.09 percentage point, to 2.35 percent in Hong Kong, according to data compiled by Bloomberg. It jumped as much as 31 basis points to 2.75 percent, the highest since September 2012. In offshore trading, the yuan fell as much as 0.27 percent to a 10-month low of 6.1722 per dollar, before trading 0.19 percent weaker at 6.1669.

The yuan’s risk-reversal gauge is “indicative of the view that the options market holds an extreme view of yuan downside risks,” Mitul Kotecha, Hong Kong-based global head of foreign-exchange strategy at Credit Agricole CIB, wrote in a note today. A breach of the 6.15-per-dollar level will probably be “short-lived” and the yuan is still on track to reach 6.0 by the end of the year as capital inflows resume, he said.

Credit Risk

Data in the past two weeks showed industrial output in January-February trailed forecasts to rise 8.6 percent from a year earlier, while growth in fixed-asset investment and retail sales also slowed. Exports slumped 18.1 percent in February, the most since 2009.

Premier Li said last week financial leverage is making the economy’s outlook more complex, while some individual cases of default are “hardly avoidable.” Shanghai Chaori Solar Energy Science & Technology Co. became the first onshore bond issuer to default this month. In January, a near-default was averted when a 3 billion yuan ($488 million) China Credit Trust Co. product that lent money to a collapsed coal miner was bailed out.

The currency has slid 2.2 percent from a 20-year high of 6.0406 per dollar reached on Jan. 14, after strengthening 2.9 percent in 2013. It fell as much as 0.86 percent on Feb. 28, the biggest intraday loss in China Foreign Exchange Trade System prices going back to 2007. The drop was also the largest since China unified official and market exchange rates at the start of 1994.

Forecasts Cut

Barclays Plc and United Overseas Bank Ltd. trimmed their projections for the yuan after the band was widened, saying the currency will not record an annual advance for the first time in five years. Barclays cut its one-month estimate to 6.20 per dollar from the previous 6.07, and its 12-month forecast to 6.05 from 5.95. UOB expects the currency to reach 6.05 by the end of December, compared with a previous forecast of 6.02.

Standard Chartered Plc reduced its end-September yuan forecast to 6.02 per dollar from 5.98, while keeping its year-end estimate at 5.92, analysts led by Robert Minikin said in a note today.

“Sharp yuan decline in the past month and widening of the trading band suggests more currency volatility is in store,” UOB Singapore-based economist Suan Teck Kin wrote in a report today. “We should not exclude the possibility of another band widening, perhaps doubling the range to 4 percent, in the second half of this year.”

Weakening Bias

The recent weakness was driven by the central bank in order to curb one-way appreciation bets before the widening of the yuan’s band, HSBC Holdings Plc strategists led by Paul Mackel wrote in a March 15 note. The currency could move toward the low end of its new trading range as the expansion is an implicit message that the authorities are comfortable with further declines, Brown Brothers Harriman & Co. strategists led by Marc Chandler wrote in a note to clients.

The central bank listed a widening of the band among its 2014 goals in a Feb. 19 statement and Governor Zhou Xiaochuan called for an “orderly” expansion in a guidebook in November that explained policy changes outlined at a Communist Party summit that month. The meeting pledged to give markets a “decisive” role in the pricing of resources, with acceleration of yuan convertibility and liberalization of interest rates among the proposals.

PBOC Intervention

While the PBOC will “basically exit” normal foreign-exchange intervention to allow markets a greater role, it will “conduct the necessary adjustment and management” in cases of abnormally large fluctuations, the central bank said in a separate statement on March 15.

Twelve-month non-deliverable forwards gained 0.05 percent to 6.2110 per dollar in Hong Kong, according to data compiled by Bloomberg. That’s a 0.5 percent discount to the onshore spot rate. The contracts fell 1.1 percent last week, the biggest weekly drop since November 2011.

“With the expansion of the trading band, greater uncertainty will be introduced for market participants,” Sacha Tihanyi, a Hong Kong-based currency strategist at Scotiabank, wrote in a note yesterday. “A more volatile exchange rate and higher fixing tendency could indeed incent hot money outflows if onshore policy makers are not careful with how they transmit their renminbi-valuation notions to markets.”

Before it's here, it's on the Bloomberg Terminal. LEARN MORE