China escalates battle against yuan bears with fixing guidance

China ramped up its efforts to stem losses in the yuan by offering the most forceful guidance since October through its daily reference rate for the managed currency.

The People's Bank of China set the so-called fixing for the yuan at 7.2076 per dollar on Thursday compared to an average estimate of 7.2994 in a Bloomberg survey, the largest gap since October. The attempted boost for the currency comes as broad dollar strength combined with evidence of China's sluggish economy helped push the onshore yuan toward a 16-year low on Wednesday.

The PBOC's move suggests it's looking to limit yuan losses exacerbated by a surprise rate cut this week, which was aimed at supporting growth. Together with a selloff in US Treasuries, that intensified focus on the widening US-China yield gap and added more pressure to the yuan, dragging it to the bottom of emerging Asia's currency rankings for the year.

The onshore yuan fell 0.2% to 7.3132 in mid-morning trading Thursday. It's down almost 6% this year.

The fixing "signals the desire of the PBOC for a more gradual move and against excessive volatility in FX but the fixing can do little to stop the depreciation trend of the yuan," said Redmond Wong, a market strategist at Saxo Capital Markets.

So far this week, the central bank has sought to stem yuan drops with stronger-than-expected daily fixings and announced an additional bill sale in Hong Kong. The latter move helped tighten yuan liquidity in the offshore market, sending a measure of the currency's borrowing cost in Hong Kong to the highest in more than a year on Wednesday.

Policymakers were also active in other markets.

On Thursday, the PBOC added 163 billion yuan ($22 billion) of cash on a net basis through reverse repurchase contracts, following the near 300 billion yuan pumped in Wednesday, the largest since February. And this week authorities asked some investment funds to avoid being net sellers of equities, according to people familiar with the matter.

A key index of shares in Hong Kong, where a majority of the members are mainland firms, looked poised to enter a technical bear market Thursday.

For now, yuan bears seem to be sticking to their guns. One-month offshore dollar-yuan risk reversals, a gauge of demand for bullish call options over bearish puts for the pair, jumped to the highest since May this week.

But others are cautious about chasing the weakness given the potential for more forceful steps from China. The central bank can follow up with more measures to stem losses, such as injecting dollar liquidity to onshore markets and making it more expensive for traders to short the currency in the forwards market, according to Goldman Sachs Group Inc.

And despite its losses versus the dollar, the yuan has been performing much better relative to trading partners' currencies. It has strengthened about 1% over the past month versus a basket of 24 exchange rates, according to a real-time Bloomberg replica of the CFETS RMB Index.

"Authorities have always been against excessive yuan volatility and letting go here would create unwanted volatility," said Eddie Cheung, senior emerging markets strategist, Credit Agricole CIB Hong Kong Branch. "I expect a very gradual climb as markets will be more sensitive to whether authorities take more action here to curb speculators."

China told state banks to escalate yuan intervention this week

Chinese authorities told state-owned banks to step up intervention in the currency market this week, in a push to prevent a surge in yuan volatility, according to people familiar with the matter.

Senior officials are also considering the use of tools such as cutting banks' foreign-exchange reserve requirements to prevent a rapid depreciation in the currency, said the people. The request came as the yuan fell toward 7.35 per dollar, a level that top leadership has been paying close attention to, they added.

Authorities were also checking whether domestic companies helped accelerate yuan declines by conducting speculative trades against it, said the people, who requested not to be named as they are not authorized to discuss the matter.

A sense of gloom has descended on China's markets this week, even though Beijing sought to bolster sentiment with a surprise interest-rate cut, a string of stronger-than-expected daily reference rates for the yuan and large injections of short-term cash to the financial system. Despite these measures, the onshore yuan is tumbling toward the weakest level since 2007 and a key index of shares in Hong Kong is close to a bear market.

China will resolutely prevent excessive adjustment in the yuan, the People's Bank of China said in its monetary policy report. The foreign-exchange market is currently in line with fundamentals, it said.

Chinese policymakers have the right tools, the experience and confidence to maintain "orderly functioning of the foreign-exchange market," the central bank said.

The PBOC didn't immediately reply to a fax seeking comment on yuan intervention.

Yuan advances

The offshore yuan extended an advance to trade 0.5% stronger at 7.31 per dollar as of 6:22 p.m. Hong Kong time, while it rose 0.2% in the onshore market.

The so-called fixing, which limits the onshore yuan's moves by 2% on either side each day and is the PBOC's favourite tool for foreign-exchange management, is becoming less useful as traders lose their patience with China's constantly underwhelming economic data. The central bank this week had to announce an additional bill sale in Hong Kong as another measure to support the yuan, effectively tightening offshore liquidity.

The PBOC still has the choice of digging deeper in its toolbag if it wishes to ramp up its fight against yuan bears. It can opt to reduce the amount of foreign currency deposits banks are required to hold as reserves, effectively injecting dollars to the system, or to make it more expensive to bet against the yuan with derivatives.