(Bloomberg) -- Pressure is building on the onshore yuan to weaken past an unofficial line in the sand for policymakers and this time traders are keeping as close an eye on happenings in Japan as they are Stateside.
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A closely-watched support level has formed at 7.20 per dollar, a level that hasn’t been breached since November, thanks in part to stronger-than-expected daily reference rates for the managed currency and state-owned banks stepping into the market when it is neared. Any indication Beijing will allow the currency to cross the line would be a signal to investors looking for further evidence of a government stepping up efforts to boost China’s spluttering economy, according to strategists.
Both Maybank Asset Management and BNY Mellon Capital Markets see the Bank of Japan’s March meeting as the next big volatility event for the yuan that could trigger such a breach. Much will also depend on Federal Reserve signaling on when it is likely to cut interest rates, a move which would give more room for China to also ease monetary policy, said Bank of America.
“If they let the fixings go and let it move higher than 7.20 that’s a signal that they’re accommodating a weaker currency and that opens up room for them to cut rates as well,” said Bank of America’s Adarsh Sinha, co-head of Asia foreign-exchange and rates strategy in Hong Kong.
China is facing a so-called impossible trinity, where it needs to stabilize the exchange rate and prevent capital outflows while keeping an independent monetary policy. Its task has been made even more challenging as a recent stock-market selloff has forced authorities to announce a spate of measures to shore up investor sentiment, on top of its daily support of the yuan.
For Beijing, currency stability is paramount so it’s the recent recovery in the dollar that is hampering their ability to enact additional support measures, according to Charu Chanana, head of foreign-exchange strategy at Saxo Bank. Bloomberg’s gauge of the greenback has climbed back to the highest since December as hawkish commentary from Fed officials pushes back expectations for a US rate cut.
“If we look at the measures the Chinese authorities have been taking, they look more like band-aid measures than anything,” said Chanana. “They are also cautious of massive stimulus measures because they do not want to see the currency weakening so much. All they can do is provide a floor rather than do anything to boost the currency.”
Still, traders should be prepared for a shift from China that potentially weakens the yuan, despite Beijing’s worries about capital outflows, according to Bank of America’s Sinha.
“At some point you just have to take that risk and try to support the economy,” he said. There’s no economic reason why 7.20 should be a line in the sand, but it’s one “definitely market participants are kind of fixated on.”
The Chinese currency was trading around 7.1960 Friday onshore. It has fallen over 1% this year.
For Bob Savage, BNY Mellon Capital Markets head of markets strategy and insights in New York, yuan traders betting on a breach of the support level should keep an eye on happenings in Japan.
Weakness in the yen has the potential to spill over into Asian peers, while Chinese authorities are likely to be sensitive to the relative attractiveness of regional currencies.
“It’s all relative to your neighbor’s pricing, the only way I could see the yuan break out of 7.20 is if you get yen to break above 152,” he said. “The BOJ could blink and not normalize, the Fed could sound more hawkish while inflation stays sticky and all of this without a BOJ response will get yen back to 152.”
The Japanese currency traded just above the 149 per dollar level on Friday, as traders parsed comments from the BOJ’s deputy governor who said it’s hard to see the bank raising its policy rate continuously and rapidly even after negative interest rates are ended.
“I do believe the dollar will start trending down in March or April,” said Rachana Mehta, co-head of regional fixed income at Maybank Asset Management. “But the most important factor may be Japan.”
--With assistance from Ran Li.
(Updates with additional context and refreshes prices.)
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