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China Confuses Yuan Traders With Surprise Changes to Fixing

China Confuses Yuan Traders With Surprise Changes to Fixing

(Bloomberg) -- Traders seeking to navigate the most crucial part of China’s foreign-exchange management are finding visibility getting increasingly cloudy.

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Since last Friday, authorities have flipped backward and forward with their favorite tool for guiding expectations — the yuan’s daily reference rate, which pins the currency to a level around which it’s allowed to deviate just 2%. Policymakers first triggered a yuan selloff partially by weakening the rate, before causing a rebound via stronger settings in the next two days.

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Rather than smoothing market jitters, the so-called fixing has become a prime reason that traders and analysts are now so divided on their forecasts. One camp says the yuan will likely stabilize because the People’s Bank of China is trying to curb its depreciation, while another argues volatility will increase as officials are trying to loosen their grip on the currency and guide it lower, perhaps to boost exports.

The mixed signals add another layer of uncertainty for yuan traders, who are already grappling with China’s gloomy growth outlook, poor investor sentiment and renewed strength in the dollar. The mixed messaging opens up room for potentially even wider swings if policymakers do decide to relax their control.

As a source of stability in the global FX market and an anchor for its regional peers, a period of increased yuan volatility risks spilling over into other currencies, even the dollar.

The PBOC’s signaling has not been “clear enough,” said Alicia Garcia Herrero, chief Asia Pacific economist at Natixis SA in Hong Kong. “It seems the first message was to weaken it, but now it is scared of a too strong weakening.”

Volatility Trigger

The latest bout of yuan volatility kicked off Friday, when the central bank weakened the fixing by the most since early February, a decision that some analysts said was Beijing signaling a willingness to let the currency decline. But then came an about-face Monday, when the PBOC set the fixing with its largest strengthening bias since November.

On Wednesday, the PBOC kept the fixing little changed, after strengthening the rate by the most since January in the previous session.

The unclear messages given by the daily reference rate are detrimental to the PBOC’s foreign-exchange management because the tool is the most important and effective method for guiding market expectations. The fact it’s announced every trading day helps officials reinforce messaging and also sets a hard barrier for currency moves. Moreover, the fixing doesn’t incur any cost on the PBOC’s balance sheet, unlike direct intervention which eats into the nation’s foreign reserves.

“There may be a new line in the sand in the interim for the yuan, although it’s still unclear where the line is,” said Fiona Lim, a senior foreign-exchange strategist at Malayan Banking Bhd. in Singapore. The PBOC is trying to walk a fine line between allowing more market pricing while controlling the pace of depreciation, she said.

Policy Hints

The fixing is seen as one of the more transparent parts of China’s currency regime as the PBOC has made it clear it is based on the onshore yuan’s previous closing level and subsequent moves in other major currencies. This means any policy hints embedded in the chosen rate are easier to trace than clues from other tools, such as window guidance, state bank dollar sales or reducing yuan liquidity in Hong Kong.

The guidelines also mean it’s possible to predict the fixing with at least some success. For much of the time, the rate hasn’t been too far away from the average estimate of traders and analysts in Bloomberg surveys that started in 2018.

The PBOC’s occasional use of the fixing to support the yuan has seldom been a surprise, even during episodes when it was set at stronger-than-expected levels — as it did in the second half of last year — because the central bank has been consistent in its messaging.

While it’s hard to conclude what the PBOC is trying to do from just a few days’ fixings, some analysts have suggested it is reacting to outside factors such as the Federal Reserve delaying a much anticipated interest-rate cut and Japan raising borrowing costs for the first time since 2007. While many argue the yuan has room to weaken amid outflows from stocks and resilience in the dollar, officials are likely to seek a slow path lower, they say.

“It seems like, for now, the existing reasons to keep yuan stable – socio-political stability, preventing larger outflows, yuan internationalization – are still offsetting the rationale for adjustment,” said Joey Chew, head of Asia foreign-exchange research at HSBC Holdings Plc. “We have to monitor the fixing every day closely.”

The PBOC didn’t immediately reply to a fax seeking comment on its latest fixing policy.

Deliberate Ambiguity

Still, other market participants say ambiguity in messaging may help the PBOC better achieve its goals. The central bank has tried to maximize the effects of its monetary policy by catching traders off guard, they say.

“As a trader of course I prefer more communication so that we can position better, however, that might be the exact thing the PBOC is trying to prevent,” said Mingze Wu, a currency trader of StoneX Financial Pte in Singapore. “Instead of front-running the central bank, letting the natural market process taking hold is not an unreasonable objective.”

(Adds PBOC’s fixing on Wednesday in 8th paragraph.)

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