What’s Up With the Chinese Yuan Breaking its Record Highs?

For the second day in a row last Friday, the People’s Bank of China (PBoC) surprised the markets by allowing the yuan to rise to its record high levels against the U.S. dollar.

Recall that in 2005 China removed its peg on the dollar in favor of a managed float to a basket of currencies. Then, in 2007 the PBoC started setting a daily central parity rate and in 2010 it pledged to increase its flexibility on the yuan’s exchange rate. Finally, in April 2012 the PBoC expanded the yuan’s daily trading band from 0.5% to 1% from both sides of its central parity rate.

But despite China’s efforts, the government is still receiving flak for not letting its currency appreciate fast enough to suit its exports competitors.

This is probably why investors were surprised last Friday when the yuan hit an intraday high of CNY 6.2654 against the dollar. The level not only surpassed Thursday’s historical high of CNY 6.2761, but it’s also the highest level since China set up the domestic currency market in 1994. Does this mean that the export-related economy is ready to welcome more currency strength?

Yuan

Market players don’t think so. They say that there weren’t any activities in the state-owned banks that suggest that the PBoC had actively strengthened the yuan. Instead, it was the Chinese companies that boosted the yuan as they sold the dollar after a week-long vacation.

If the PBoC isn’t too keen on boosting the yuan, then why did it allow the currency to reach its record highs? Is it because the central bank is confident that the yuan won’t rise much anyway thanks to the recent underperformance of the economy?

Analysts believe that the PBoC isn’t actively restricting the yuan’s strength because China is taking care to avoid being labelled as a currency manipulator. Now this not-so-old man isn’t one to easily believe in rumors, but you gotta admit that the market bees are making a good case.

For one thing, the U.S. Treasury was scheduled to release its semi-annual currency report this week. In its report last May, the Treasury Department had already accused China that its “significantly undervalued” currency is weighing on global growth. The department recently delayed its release to November though, so we’ll have to wait for a couple more weeks to see if the PBoC’s moves had any impact on the currency report.

And then there’s the upcoming U.S. elections. With the elections only a few weeks away, the yuan’s recent strength would make it difficult for politicians to label China as a currency manipulator and blame the Chinese government for the widening trade deficit and the weakening U.S. economy.

We don’t know for sure what the PBoC’s reasons are for letting its currency appreciate to its record highs. We’ll likely find out over the next few weeks if the central bank’s moves are sustained, necessary, or even effective. In the meantime, keep your eyes peeled for any speeches or news report that might give us clues on the direction of the yuan.