Yuan Fixings Enigma Returns as PBOC Reverts to Currency Basket

China Cuts Reserve Ratio in Latest Economic Boost
  • Reference rate is `as black-box as ever': ING's Condon
  • Moves have become more volatile since the Lunar New Year

The Chinese central bank’s yuan fixings are becoming more erratic as policy makers adjust it more freely versus the dollar, heightening the risk of surprises in the closely watched indicator.

The People’s Bank of China kept moves in its daily reference rates to a maximum 0.02 percent most days in the month leading up to the Lunar New Year break that began Feb. 7, after a run of declines spurred a $4 trillion global stocks sell-off in the first week of January. Changes have averaged about 0.1 percent in the two trading weeks since the holiday and Tim Condon, ING Groep NV’s head of Asia research, wrote in a Feb. 24 note that the fixings were "as black-box as ever."

QuickTake The People's Currency

One interpretation is that the PBOC may be returning to a plan outlined last year to use a basket of currencies rather than the greenback as the yuan’s main reference, according to HSBC Holdings Plc and Australia & New Zealand Banking Group Ltd. Roy Teo, a Singapore-based analyst at ABN Amro NV, Bloomberg’s top-ranked forecaster for the yuan, said the authority may be favoring random fixings "to confuse speculators as to what their bias is."

"Their strategy is not to reveal their plan," said Khoon Goh, a foreign-exchange strategist at ANZ in Singapore. "Perhaps they’re now more willing to have more two-way volatility against the U.S. dollar as long as the renminbi basket remains stable."

Recent moves to reference the yuan against a basket of currencies have "now taken shape," the PBOC said in a statement Friday. "The current regime is able to better reflect market supply and demand, remain broadly stable vis-a-vis a basket, and anchor market expectations," it added.

Central bank Governor Zhou Xiaochuan Friday confirmed that the greenback plays the biggest role in the basket. He was responding to a question on how market participants can better understand currency policy when China asserts that the yuan is pegged against the basket while setting the fixing against the dollar.

The yuan has gained 0.44 percent versus the greenback in February to 6.5481 as prospects for a U.S. interest-rate hike dimmed, after losing 1.3 percent last month. The fixing was cut 0.2 percent last week and another 0.17 percent on Monday to 6.5452 as the dollar rebounded. The spot rate cannot deviate more than 2 percent from the fixing.

While the convergence between the fixing and the spot rate since August has made the trading band less relevant, the reference rate still befuddles strategists.

After enforcing a de facto dollar peg for three months, the PBOC slashed the fixing by the most on record on Aug. 11. At the time, it said the rate will take into account moves of major currencies, the previous day’s close and other factors -- with the last giving the PBOC room to maneuver. The changes were part of efforts to aid the yuan’s entry into the International Monetary Fund’s basket of reserve currencies.

In December, China unveiled the trade-weighted CFETS RMB Index, saying that the yuan’s performance shouldn’t be measured against the dollar alone. Governor Zhou said in an interview with Caixin magazine this month that while the basket will play a bigger role, China won’t peg the yuan to the index as there are many factors affecting the exchange rate. He said also that China’s balance of payments position is good, capital outflows are normal and there’s no basis for the exchange rate to depreciate continuously.

"Since August last year, the currency has become more correlated to the RMB index, except for periods of global financial market stress, when China opted to pause temporarily," said Wang Ju, a currency strategist at HSBC in Hong Kong. "Foreign-exchange reforms resumed last week after stability in financial markets. The PBOC is reinstating the RMB index basket and the correlation between the yuan’s daily fixing and overnight dollar moves."

A Bloomberg replica of the index peaked at 105.6 on the eve of the August devaluation, and has since dropped to 99.3.

While the PBOC is still likely to strengthen the fixing if the greenback falls broadly overnight, the magnitude of the adjustment has become harder to project, said ANZ’s Goh. The dollar has the biggest weighting in the CFETS RMB index with 26.4 percent, followed by the euro and the yen.

"At this stage, it’s not about credibility for them," he said. "It’s all about initially trying to stabilize the currency when depreciation expectations were getting out of hand, then trying to get convergence between the three different rates, which they have succeeded in doing. Now they’re just trying to take the next step, focusing on the basket rather than just against the U.S. dollar and allowing more two-way volatility."

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