Offshore Yuan’s Worst Drop in Four Months Evokes January Turmoil

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Deep Dive Into the Offshore Yuan’s Drop
  • Currency falls 0.5% overnight after Fed releases minutes
  • Onshore yuan declines to lowest level in more than 11 weeks

The offshore yuan slid the most since January overnight as minutes of the Federal Reserve’s last meeting put the prospect of a June interest-rate hike on the table.

The Chinese currency slumped 0.5 percent on Wednesday to the lowest level since Feb. 3. The retreat came as the dollar surged the most in six months after the Fed record showed most officials want to raise rates next month should the U.S. economy continue to improve. The yuan rose 0.2 percent in Hong Kong’s freely traded market as of 5:25 p.m., while falling to an 11-week low in Shanghai.

A resurgent greenback is shaking up a strategy that the People’s Bank of China pursued over the past three months -- a steady rate against the dollar, combined with depreciation against other major currencies. While there are few signs of the fear that gripped global markets in January, when the yuan sank 1.5 percent in just a week, investors are watching the currency as a barometer for the health of the world’s second-largest economy.

"I don’t think investors will be as panicky as in January, as they understand the PBOC won’t want to see such turmoil happening again,” said Gao Qi, a strategist at Scotiabank in Hong Kong. “But if the expectation for the Fed to raise interest rates continues to exist, the yuan will face depreciation pressures."

Slowing Growth

China’s markets are coming under stress as a slowdown in the economy deepens. The Shanghai Composite Index closed at its lowest level in more than two months on Wednesday, while the yield on the nation’s 10-year sovereign debt rose to 2.96 percent, the highest since December. Industrial production, retail sales and investment in April all trailed estimates as new credit undershot all 26 predictions in an analyst survey.

There are signs China’s policy makers are prepared to allow greater economic hardship. The nation should put deleveraging ahead of short-term growth and drop the “fantasy” of stimulating the economy through monetary easing, the People’s Daily cited an unnamed “authoritative person” as saying this month. Officials reporting directly to President Xi Jinping are in control of policy now, and they are more willing to endure the pain of reforms, Daiwa Capital Markets said this week.

China’s Dilemma

The one-month implied volatility on the onshore yuan, a gauge of expected price swings, rose as much as 23 basis points to a six-week high of 5.04 percent on Thursday, according to data compiled by Bloomberg.

Any decision by the Fed to raise interest rates would highlight the dilemma facing China’s central bank. Allow the yuan to rise with the greenback and China eases fears of devaluation at the expense of the nation’s exporters. Permit further losses against the trade-weighted basket, and it risks spurring destabilizing outflows, as seen earlier this year. The Bloomberg Dollar Spot Index was little changed after jumping 0.8 percent on Wednesday.

The signal that next month’s Fed gathering may be in play came a day after strong data on consumer inflation, housing starts and industrial production, sending odds on a rate hike in June to more than 30 percent, from just 4 percent a week ago.

— With assistance by Tian Chen, and Helen Sun

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