China’s Offshore Yuan to End Slide on Reserves: Market Reversal

China’s yuan is set to pull out of its steepest slide since 2011 in offshore trading as the nation’s $3.8 trillion of foreign reserves coupled with inflows from trade and investment deter bets on further losses.

The yuan slumped 1 percent against the dollar in Hong Kong last week, leading declines among Asian currencies, as a report showed China’s manufacturing is shrinking at the fastest pace in seven months. A measure known as the relative-strength index rose to the highest since June 2012, signaling the yuan’s drop may be overdone, while the currency closed 0.03 percent stronger than its 200-day moving average, which often becomes a support level where buy orders are clustered.

“The drop in the offshore yuan is a buying opportunity,” Jonathan Cavenagh, a Singapore-based strategist at Westpac Banking Corp., said in a Feb. 21 phone interview. “The solid foreign-exchange reserves position and the still healthy current-account situation, I would highlight. We would warn against getting too bearish on the outlook.”

China’s yuan, which reached a two-decade high last month, is finally reflecting evidence that the world’s second-largest economy is slowing. Some traders say it has tumbled too far, too fast given that China has the largest foreign reserves ever amassed and that its current-account surplus widened to $189 billion in the fourth quarter.

China’s Finance Minister Lou Jiwei played down yuan declines and the risks from shadow banking yesterday as he attended a meeting of Group of 20 finance ministers in Sydney, while central bank Governor Zhou Xiaochuan signaled the nation’s economy can sustain growth of 7 percent to 8 percent in a statement on the authority’s website.

Best Performer

The yuan has risen 36 percent against the dollar in Shanghai since China scrapped a dollar peg in July 2005, the best performance among 24 emerging-market currencies. Bloomberg strategist surveys indicated on Feb. 21 it would lead Asian gains for the remainder of this year with a 2 percent advance.

Last week’s slide in the offshore yuan was the biggest since September 2011 and erased the gap with the onshore exchange rate, according to data compiled by Bloomberg. The yuan cost 0.02 percent less in Hong Kong than Shanghai at the end of last week, down from a 0.6 percent premium on Feb. 7 that was the biggest since Jan. 2012.

The yuan in Hong Kong halted a five-day decline today, advancing 0.02 percent to 6.0922 per dollar as of 3:49 p.m. local time. That was within 0.02 percent of the the Shanghai exchange rate, which fell 0.02 percent to 6.0929.

Weakness in the offshore yuan will be limited because of investment flows and the convergence with the onshore rate, Ju Wang, a Hong Kong-based currency strategist at HSBC Holdings Plc, wrote in a Feb. 21 report. The offshore exchange rate will strengthen to 5.98 by the end of December, she predicted.

Reference Rate

China has onshore and offshore exchange rates for the yuan. The onshore version slid 0.4 percent last week to 6.0919 per dollar, according to China Foreign Exchange Trade System prices, as the People’s Bank of China weakened its reference rate by 0.17 percent. The spot rate was 0.4 percent stronger than the fixing, within the 1 percent limit of its trading band, and its 14-day relative strength index was 77, above the 70 threshold that indicates a turnaround is likely.

The monetary authority extended last week’s decline in the fixing by cutting the reference rate by 0.02 percent today to a two-month low of 6.1189. That was the fifth straight cut, the longest run of reductions since November.

‘Oversold Territory’

“The onshore and offshore yuan spots are in oversold territory and markets should stabilize at these levels,” said Dariusz Kowalczyk, a Hong Kong-based strategist at Credit Agricole SA. “The outlook depends on speculation regarding yuan-band widening, which is a key driver of spot weakness.”

China’s central bank said last week it plans to expand the yuan’s trading band in an “orderly” manner in 2014, while broadening cross-border usage of the currency. The band was doubled in April 2012 from 0.5 percent, and before that widened from 0.3 percent in May 2007.

A factory gauge by HSBC and Markit Economics Ltd. showed a preliminary reading of 48.3 on Feb. 20, less than the 49.5 median estimate in a Bloomberg survey of economists. A number below 50 indicates contraction. China’s gross domestic product will increase 7.5 percent this year, the least since 1990, according to a separate survey.

Bollinger Band

After the yuan’s daily trading range in Hong Kong last breached the upper end of its Bollinger band in 2012, the currency went on to climb to 6.2095 per dollar that November, from 6.3995 on Aug. 3.

Developed by John Bollinger in the 1980s, the bands are used by technical analysts to identify the turning point in an asset’s trajectory. The limits represent two standard deviations from the 20-day moving average, implying that the likelihood of a currency moving outside the band is small.

The offshore yuan’s relative strength index rose to 80 on Feb. 21. When it reached a record-high 84 on June 1, 2012, the currency gained 0.1 percent that month, after tumbling 1.04 percent in May.

The dollar’s 20-day commodity channel index against the Chinese currency climbed to 445 on Feb. 21, another sign the greenback is too strong versus the yuan.

“The offshore yuan’s decline should halt around here, probably ahead of the 200-day moving average as indicators like Bollinger band and the RSI show it’s oversold,” Minoru Shioiri, a Tokyo-based manager in the credit and foreign-exchange trading division at Mitsubishi UFJ Morgan Stanley Securities Co., said in a Feb. 21 phone interview. “The yuan will probably rebound to around 6.05 in the short term to stabilize, while appreciation pressure in the much longer term from the current-account position still remains.”

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