Yuan Gap Narrows as PBOC Seen Backing Currency Amid Fed Concern

  • Offshore yuan strengthened beyond onshore rate this week
  • Sovereign bonds drop for fourth week, longest run in a year

The offshore yuan’s discount to the rate in Shanghai narrowed this week amid bets the central bank will step in to curb volatility as the Federal Reserve prepares to raise interest rates.

QuickTake The People’s Currency

The closing of the gap is an indication of reduced pessimism among global funds. Options traders are putting the probability of the yuan dropping to 7 a dollar by the end of 2016 at 13 percent, from more than 30 percent in January. The yuan has risen against a basket of currencies in May amid a dollar rebound, signaling the People’s Bank of China’s intention of keeping the currency stable.

The offshore yuan fell 0.03 percent for the week to 6.5669 a dollar as of 4:30 p.m. in Hong Kong, while its onshore counterpart fell 0.16 percent to 6.5596 in its fourth weekly drop in a row. The rate in Hong Kong strengthened beyond the onshore price for the first time in three weeks on Thursday, and was 0.1 percent weaker on Friday, compared with a record 2.9 percent in January.

"The pace of yuan depreciation is not fast and disorderly," said Fiona Lim, a senior currency strategist at Malayan Banking Bhd. in Singapore. "Markets are still undecided on whether the Fed would move in June and are awaiting more confirmation from Yellen."

The odds of the Fed raising rates in June has jumped to 28 percent from 4 percent less than two weeks ago. U.S. central bank Chair Janet Yellen is set to speak at an event in Massachusetts later Friday in comments investors will weigh to gauge the outlook for borrowing costs after several officials signaled the possibility of an increase next month.

China raised the yuan’s daily reference rate, which restricts onshore moves to a maximum 2 percent on either side, by 0.09 percent Friday after the dollar declined. The onshore currency has declined 1.2 percent this month so far.

The current bout of yuan weakness is different from that during the devaluation in August, Bilal Hafeez, the London-based global head of foreign-exchange research at Nomura Holdings Inc., wrote in a note. Expectations for Chinese economic growth are already low and the global environment is more benign, he said.

The PBOC has continuously increased the two-way flexibility of the yuan’s exchange rate and maintains basic stability, the monetary authority said in a statement on its microblog on Friday. This came after the Wall Street Journal reported that the central bank scrapped its market-based mechanism for managing the yuan on Jan. 4. Friday’s post also denied a report that said it would ask the Fed about the time of any increase in interest rates.

Bonds Decline

Ten-year government bonds fell for a fourth week, the longest run of losses since May last year. The yield rose one basis point to 2.96 percent, ChinaBond data show. The seven-day repurchase rate, a gauge of interbank funding availability, climbed 10 basis points from May 20 to 2.37 percent, according to National Interbank Funding Center prices.

The PBOC injected funds into the financial system for a second week, adding a net 70 billion yuan ($10.7 billion) via open-market operations. The central bank also auctioned 40 billion yuan of three-month treasury deposits on behalf of the Ministry of Finance at 3.2 percent on Friday, in line with the interest rate in the last sale in November.

“The chance for yields to climb far exceeds that of a decline,” said Ming Ming, a Beijing-based analyst at Citic Securities Co. “Externally, the market is worried about the potential interest-rate increase in the U.S., and internally, inflation is likely to creep higher. And given the pressure on the currency, these are all negative factors to the bond market.”

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