(Bloomberg) -- The offshore yuan tumbled the most in almost seven months after China’s central bank took steps to restrain the currency’s rally.
The exchange rate slumped as much as 1.03% against the dollar in late Hong Kong trade on Monday. Declines steepened without an obvious trigger just before the 4:30 p.m. official close of the onshore rate, which helps determine the next day’s reference rate. The drop may mark the start of a period of consolidation after recent gains, strategists said.
The People’s Bank of China on Saturday scrapped a two-year rule that made it expensive to bet against the yuan after the currency surged to its highest in 18 months. The PBOC had in recent weeks refrained from sending clear signals on the yuan, reinforcing speculation that policy makers looking to boost consumption at home wanted a stronger yuan.
But as gains accelerated, it appears officials grew concerned the currency risked becoming a one-way bet. Reasons to buy the yuan were many. Polls showing Democrat Joe Biden may win the election. Failed U.S. stimulus talks driving the dollar lower. An attractive yield gap over Treasuries. An upcoming Communist Party plenum this month where stimulus measures are expected to be announced.
“China is just taking preemptive action to keep the yuan steady as the U.S. election could add even more appreciation pressure,” said Ken Cheung, chief Asia currency strategist at Mizuho Bank Ltd. “The yuan will be anchored for the time being -- we see it trading in a 6.7-6.8 range in the near term.”
The offshore rate was down almost 0.9% at 6.745 at 7:06 p.m., while on the onshore yuan last traded at 6.749.
The late slump may have been driven by short covering. Three traders said some proprietary desks at onshore banks closed their short dollar trades. Thin liquidity exacerbated the short squeeze, said the traders, who declined to be named as they’re not authorized to speak to the press.
The declines prior to the 4:30 p.m. close will enable the central bank to set a weaker reference rate -- known as the daily fixing -- on Tuesday. The yuan can move 2% in either direction of that rate. The rate was fixed at 6.7126 per dollar on Monday, compared with the average estimate of 6.7073 in a Bloomberg survey.
The central bank has other tools at its disposal to influence the yuan, including driving up the cost of betting against the yuan offshore and controlling the flow of funds in and out of the country.
Effective Monday, financial institutions no longer need to set aside cash when purchasing foreign exchange for clients through currency forwards, according to a statement from the PBOC on Saturday. Back in September 2017, when the PBOC similarly cut the cost to zero following sharp gains, the yuan slumped about 2.5% in the next three weeks.
Banks previously had to hold 20% of sales on some foreign exchange forward contracts, a move imposed two years ago when the currency slumped toward 7 per dollar.
Officials will be wary of upsetting currency markets through too forceful intervention. An unexpected yuan devaluation in 2015 triggered global market turmoil as well as a wave of capital outflows, before Beijing tightened curbs to limit outflows and brought the currency under control.
Authorities are likely to favor stability in the yuan over the next few weeks at least given the potential for currency upsets in the U.S. elections.
“The PBOC will want to ensure the yuan is anchored as the dollar could be volatile,” said Khoon Goh, head of Asia research at Australia & New Zealand Banking Group Ltd. in Singapore. “We are likely to see a period of consolidation in the yuan.”
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