PBOC’s New Normal Keeps Traders Guessing as Yuan Surges

Chinese policy makers have been saying since February that two-way swings in the yuan are the “new norm.” A surprise surge in the currency shows that they mean it.

Twelve-month non-deliverable forwards, which traders use to speculate or hedge, strengthened 0.9 percent against the dollar in the past three days, their biggest advance since January 2012. The rally follows five months of declines that investors attributed to an effort by the People’s Bank of China to weaken the yuan and fend off speculators who were anticipating a continuation of a five-year rally.

Just as traders got used to a declining yuan in recent months, the currency changed direction again after the government reported the country’s trade surplus almost doubled and the central bank set the reference exchange rate today at the strongest level since March. The PBOC’s efforts to inject volatility and reduce speculation are gaining traction as currency strategists from Barclays Plc to Westpac Banking Corp. disagree on whether the yuan’s strength can last.

“The move is more about mixing it up and increasing volatility, just as they said they would,” Edmund Harriss, investment director in London at Guinness Atkinson Asset Management LLC, which oversees a Chinese bond fund among $800 million in client money, said by phone yesterday. “I see the yuan continuing to trade that way.”

Worst Performer

The PBOC raised its yuan fixing by 0.42 percent to 6.1451 per dollar in the past three days, including a 0.22 percent increase yesterday that was the biggest since October 2012. The spot rate, which is allowed to fluctuate 2 percent above or below the official quote, rose 0.3 percent today to 6.225 in Shanghai, China Foreign Exchange Trade System prices show.

The yuan has lost 2.8 percent this year, the worst performance among major Asian currencies. It started to slide after it hit a two-decade high in January as the central bank warned that it may take measures such as imposing taxes to prevent speculative money from flowing into the country.

Two-way capital flows will become the “new norm” for China and the exchange rate is likely to be more volatile, the foreign-exchange regulator said in February. Policy makers doubled the yuan’s trading band around the central bank’s reference rate in March as part of plans to give the market a greater influence in determining the exchange rate.

Different Opinions

The currency’s rebound in the past three days has been met with diverging opinions among analysts on whether the yuan’s weakness is ending.

The central bank’s June 9 fixing diverged by the most this year from the level Westpac’s model had predicted, suggesting a “fairly clear shift” in the PBOC’s bias toward capping the weakness of the yuan, Singapore-based currency strategist Jonathan Cavenagh, wrote in a note yesterday.

Cavenagh said he’s “turning more upbeat” on the yuan after recent economic data showed the economy is improving.

Exports climbed 7 percent from a year earlier in May, official data showed on June 8, compared with growth 0.9 percent in the previous month and the median estimate of a 6.7 percent gain in a Bloomberg News survey. That left a trade surplus of $35.9 billion, almost double the figure for April, as imports unexpectedly fell 1.6 percent.

“Such a turnaround in the trade picture, which arguably reflects a more genuine improvement, should be supportive” for the yuan over the coming months, Cavenagh wrote.

Yuan Bulls

BNP Paribas SA and Credit Agricole SA turned bullish on the currency at the end of May.

Mirza Baig, head of Asia foreign-exchange and interest-rate strategy at BNP, recommended his clients buy the yuan on May 27, saying that the central bank has eased its currency intervention and rising yields in the forwards are making it more attractive. Frances Cheung, head of Asian rates strategy at Credit Agricole, advised a similar trade the following day.

At Barclays, strategists are unconvinced. An unexpected decline in imports last month suggests investment growth remains weak with downside risk to the economy, economists led by Jian Chang wrote in a report yesterday.

“Looking ahead, we see the currency to remain at the current level with some room for further depreciation if growth continues to disappoint,” Chang said.

The State Council asked the PBOC to increase two-way flexibility in the yuan and keep the exchange rate relatively stable at a reasonable equilibrium level, according to a May 15 statement on the central government’s website.

Options Prices

One-month implied volatility in the onshore yuan, a gauge of expected moves in the exchange rate used to price options, rose for a second day, increasing 4 basis points, or 0.04 percentage point, to 1.48 percent as of 9:25 a.m. in New York, data compiled by Bloomberg show. The gauge climbed to a two-year high of 2.54 percent on March 20.

“The PBOC is serious when it claims that the yuan is subject to greater two-way risk,” Tim Condon, head of Asian research in Singapore at ING Groep NV, wrote in a note yesterday. He cut his year-end yuan forecast to 6.25 per dollar from 6.22.

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