In case you’ve been too busy looking up recipes for the Thanksgiving holidays, you should know that the People’s Bank of China (PBoC) has weakened the yuan not once, not twice, but twelve times against the dollar for the past couple of days. What’s up with that?!
Wait a minute. What do you mean by “weakened?”
Unlike most of the major economies that allow their currencies to float freely against other currencies, China regulates the yuan’s price action by setting a “mid-point fix” against the dollar each day and allowing it to strengthen/weaken within a trading band.
In August 2015, the PBoC widened said trading band and announced that it would now consider the previous day’s closing price as well as its performance against a basket of currencies in its computations.
What caught the market players’ attention was that the PBoC had set its USD/CNY fix higher for TWELVE consecutive days. That’s the longest streak on record! The pair hit 6.8985 yesterday, a high not seen since June 2008 and put USD’s gains to 2.2% during the 12-day stretch. The PBoC finally stopped the party today when it set the fix down to 6.8779.
Why would the PBoC weaken its currency that much?
There are tons of reasons but we can narrow them down into three main points:
Playing catch-up to USD’s recent gains
Remember that the dollar has been dominating the forex scene since Trump won the Presidential elections. Traders decided that Trump’s infrastructure and tax cut plans could only be good for America’s companies so they’ve been selling U.S. bonds and buying the U.S. dollar like there’s no tomorrow.
The PBoC might be prepping for Trump
President-elect Trump has been clear from the beginning that he wants to brand China as a “currency manipulator” and is planning to revisit Uncle Sam’s trade deals with the world’s second largest economy. With its latest moves, the PBoC is either tweaking Trump’s nose before he takes office in January, or it might be preparing to adjust its currency higher once Trump calls China out.
It’s already part of the IMF’s SDR
The best reason why the PBoC is weakening its currency is because it can. Back in December, the IMF officially allowed the yuan to be included in its Special Drawing Rights (SDR) table, which makes it easier for major economies to get their hands on China’s currency. Now that the yuan is officially part of the SDR, there’s less pressure on the PBoC to behave and show that its currency is stable enough to become part of the club.
What does a weak yuan mean for forex traders?
Though traders can’t trade the yuan as easily as the other currencies, its rate of decline is still a concern for investors.
See, a rapidly depreciating currency has fuelled capital flight from the economy, something that the PBoC doesn’t want to see especially since it’s been working hard to boost domestic investment. Less domestic investment would also mean less growth, which is bad news for a lot of China’s trading partners across the globe.
But with the dollar’s prospect still bullish in the short-term, it’s likely that the yuan will continue to weaken against the Greenback over the next couple of days. In this case, the PBoC will face pressure to prevent capital flight either by implementing stricter capital controls or directly intervening in the market. For now though, it seems like 13th day is the charm for the PBoC.