Trying to second-guess China’s policymakers is usually futile, so no one should have been surprised when the People’s Bank of China (PBoC) raised its USD/CNY fixing on March 22 by the largest amount since the start of the year.
The move enabled USD/CNY to trade through 7.20 for the first time since November 2023 and led to speculation that China’s central bank could move towards a managed depreciation regime, where the daily fixing is increased slowly, but at a pace dictated by the upper bound of its 2% trading range.
Simon Harvey, head of FX analysis at Monex Europe, thinks this is unlikely. He says capital outflow pressures, the likely impact on investor and consumer confidence, and yuan depreciation are threatening China’s longer-term economic objectives of rebalancing the economy away from exports to consumption-driven growth and internationalizing the use of the yuan.
While the yuan is seen as expensive on a nominal trade-weighted basis, China’s exports remain highly competitive once adjusted for inflation
Simon Harvey, Monex Europe
“While the yuan is seen as expensive on a nominal trade-weighted basis, China’s exports remain highly competitive once adjusted for inflation, meaning there is little growth benefit from allowing the yuan to weaken,” he says. “The bank is likely to use the same playbook as last year, utilising quasi-intervention by state banks, making regulatory tweaks and adjusting liquidity conditions to make financing short positions more punitive.”
This view was reinforced by the PBoC’s decision to lower the renminbi reference rate just days later.
According to José Torres, senior economist at Interactive Brokers, these changes were likely to have been a result of muddled thinking. The central bank continues to struggle to improve the country’s economy despite having friendly monetary policies, while elected officials have launched fiscal stimulus.
“The central bank’s thinking on stimulus and currency appears offbeat as it hasn’t generated the growth it has targeted, and it is seeking new ways to help the economy,” he says. “After it fixed its currency significantly this year, the yuan strengthened and the bank then reduced its support, reflecting uncertainty about how the currency should be managed.”
Traders have struggled to interpret these moves. On the one hand, they cause uncertainty and additional volatility and raise questions about the central bank’s behaviour. But they can also be seen as an attempt to show the markets that the Chinese authorities have the power to move the yuan any way they like.
The central bank’s thinking on stimulus and currency appears offbeat as it hasn’t generated the growth it has targeted, and it is seeking new ways to help the economy
José Torres, Interactive Brokers
“It could additionally be viewed as a deliberate attempt to keep traders off-balance if the yuan approaches its daily trade limits,” suggests David Morrison, senior market analyst at Trade Nation. “All this is contributing to an unnecessary increase in concerns from investors.”
John Kicklighter, global head of content at StoneX, notes that China’s financial authorities do not seem to pursue policy via committee and were more likely to be testing the water to see how far the free market would run.
“When it was clear that exogenous pressure would push exchange-rate leniency to the extreme, corrective measures were enacted,” he says. “However, with domestic growth struggling amid high yield and real estate-led financial uncertainties, it would not be a surprise to see exchange-rate policy exhibit some unusual trend and volatility actions.”
While acknowledging the mixed signals from policymakers, Nikos Tzabouras, senior market specialist at Tradu, reckons this reflects the complexity of the task. He does not rule out intentional ambiguity as the task of managing the currency becomes increasingly difficult.
Official fixing
According to the authors of JPMorgan’s latest weekly FX markets report, the risk is that policymakers lighten up rather than tighten further on FX moves.
“The fact that the fixing is announced every trading day helps officials strengthen communication and also provides a hard barrier to currency movements,” explains XTB analyst Mateusz Czyżkowski.
In addition, the fixing imposes no cost on the central bank’s balance sheet, unlike direct intervention, which is a drain on the country’s foreign-exchange reserves.
Alexander Kuptsikevich, senior analyst at FxPro, plays down any suggestion of dissent in the ranks, noting that the official fixing is sometimes characterized by fluctuations that look as chaotic as the market rate.
Analysts and traders pay attention to whether the official fixing was above or below the market price and how big this difference was
Alexander Kuptsikevich, FxPro
“In this case, analysts and traders pay attention to whether the official fixing was above or below the market price and how big this difference was,” he says. “By this differential the market tries to understand whether the central bank is pushing the rate up or down.”
Peter Rosenstreich, head of investment products at Swissquote, agrees that the PBoC always allows a level of volatility that keeps traders guessing. He suggests it is likely to lean into a weaker renminbi.
“There is a growing risk of a doom spiral, where prices fall due to weak demand and demand stays weak as households postpone spending in the hope of further price reductions,” he says. “These realities have implications for China’s exchange-rate policy, in that a weaker CNY could help eliminate China’s deflationary psychology before it takes root by raising the domestic price of imported goods.”
Fixing volatility is part of the central bank’s unofficial ease-and-squeeze strategy of keeping traders on their toes and preventing a build-up in one-sided bearish positioning, according to Ben Laidler, global markets strategist at eToro.
He says China is attempting to square the interest-rate policy circle by focusing on cutting high bank reserve-requirement ratios to boost liquidity in the economy, rather than cutting interest rates that could put pressure on the currency.
Policymakers are caught between a rock and a hard place, having to balance shoring up investor sentiment with tolerating sufficient currency weakness to help support growth.
“Ultimately, we wouldn’t be surprised if Beijing allows for further currency weakness, which has been an oft-used policy lever to offset economic pressures,” says Alexey Efimov, market analyst at Alpari.
