China reportedly tweaks yuan fix

Markets reacted by selling the yuan, which fell 0.5% against the US dollar to 6.5291 from 6.4968 on Tuesday

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Analysts say a stronger yuan against the dollar has helped the PBoC feel more comfortable about tweaking the fix

The People’s Bank of China has reportedly changed the way it calculates the yuan’s daily fix by suspending the counter-cyclical factor it introduced in May last year when the currency was under strong depreciation pressure.

According to a report from Bloomberg, banks that contribute to the daily USD/CNY reference rate were told by the central bank to remove the effect of the CCF by adjusting the central parity exchange rate formation mechanism, which is based on the closing price of the previous day and the exchange rate movement against a basket of currencies.

The move suggests the PBoC is now more confident the yuan will be less likely to fall victim to bouts of high volatility caused by speculative flows, as often happened in the early part of last year.

“Amid relatively steady economic fundamentals, restrictions over capital flows and US dollar weakness, the central bank may be removing the CCF. Indeed, compared to most of last year when the CCF was often negative and larger, the CCF has recently been zero more often, or smaller in size,” says Irene Cheung, a senior strategist for Asia at ANZ.

“Of the 21 trading days in the past month, there were 12 days when the CCF was zero. This suggests that the spot rate now often trades below the fix. Hence there has been a sharp decline in negative sentiment in the yuan,” she adds.

Markets reacted by selling the yuan, which fell 0.5% against the US dollar to 6.5291 from 6.4968 on January 9 – its biggest drop in two months. The consensus among forecasters contributing to FX Week is for USD/CNY to trade at 6.68 in 12 months’ time.

“I think this is short-term negative for the currency as the countercyclical factor provided a natural drag lower to USD/CNY, as any large US dollar move on a given day was discounted via the countercyclical factor, creating an asymmetry,” says Stephen Rishworth, head of trading at HSBC. “With this removed, it can put a short-term bid in USD/CNY and USD/CNH.”

“Despite this seeming short-term negative, the removal of the countercyclical factor speaks to the confidence the authorities now have about potential outflows, and so it speaks to a more medium term positive outlook for the currency, at least from a stability perspective,” he adds.

When the China Foreign Exchange Trade System (CFETS), the trading entity run by the PBoC, announced the introduction of the countercyclical adjustment factor on May 26, 2017, it said changes to the mechanism were part of its efforts to create a more transparent, market-oriented exchange rate.

But while analysts agreed the new methodology had the potential to drastically reduce speculative action from participants in offshore markets, they warned the influence of the official closing spot rate would also be reduced, making the fixing less predictable and transparent.

“We maintain that the fixing mechanism is an evolving process that will likely continue to see adjustments along the way. Instead of providing strong guidance to the market via the CCF, the latest move will return some autonomy to the market mechanism in determining the level of the yuan,” Cheung says.

“While the long-term plan is to liberalise the yuan, the pace and timing hinge on the global and domestic environment at that point in time – whether it is conducive and workable for China to further deregulate the currency. Note that the latest move is to suspend the CCF, not to abolish it, perhaps providing room for the central bank to modify/re-introduce it in some form if such a need arises,” she adds.

While the long-term plan is to liberalise the yuan, the pace and timing hinge on the global and domestic environment at that point in time – whether it is conducive and workable for China to further deregulate the currency

Irene Cheung, ANZ

A stronger yuan

Analysts say a stronger yuan against the dollar over the past 12 months has helped the PBoC feel more comfortable about tweaking the fix. In September, the central bank scrapped two reserve requirements it put in place to curb capital outflows and speculation against the yuan – in another sign that Beijing authorities are less concerned about the depreciation of the currency.

Last year the yuan appreciated by 6.8% against the greenback, reversing the trend witnessed in 2016, when the PBoC was forced to deploy reserves of more than $300 billion to defend the yuan from speculation.

Rigorous capital controls imposed last year, including a set of measures limiting the amount of FX purchases by individuals and restrictions on foreign acquisitions, have helped to stabilise capital outflows from the mainland and reinvigorate the FX reserves stockpile.

Figures published on January 7 by the PBoC show FX reserves increased by $20.2 billion to $3.14 trillion at the end of December, the biggest monthly increase since July 2017 and the 11th consecutive monthly increase.

Ever-changing formation mechanism

The yuan-fixing mechanism has undergone several changes over the past three years. In August 2015, the PBoC announced it would change the formation of the currency’s central parity rate against the US dollar by taking into consideration the previous day’s closing rate in interbank markets.

In January 2016, China’s authorities introduced a composite index that compared the previous day’s onshore closing spot rate with the average value of 13 other currencies weighted to the trade volume on the mainland.

In January 2017, CFETS expanded the number of currencies included in the basket to 24, allowing a higher number of emerging market currencies to influence the daily fix. The following month it shortened the timeframe during which the movement of the basket is calculated, from 24 to 15 hours, between 4:30pm the previous trading day until 7:30am.

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