The PBoC could’ve easily set their fixing above 6.7 last week on the back of a stronger dollar. This is the perfect excuse to go beyond the psychological barrier of 6.7 – to protect the credibility of the market-based fixing methodology without a depreciative bias.
Setting the fixing lower will only reduce the credibility they have painstakingly built since February. Moreover, markets have been calm and obedient despite the PBoC engineering a staggering 8.31% depreciation in the CFETS Index since Nov 2015. This calmness has largely been attributed to (1) better communications from officials; (2) increased transparency in fixing methodology; (3) pause in monetary policy since Oct 2015 and (4) the government increased clampdown on outflows.
Yet, they set the fixing lower on Tue and Wed last week (see table below) when estimated fixing was above 6.70. Even on Friday, they continued to set the fixing lower, prompting FM community to sell USDCNH on rally as an interpretation of PBoC’s firm commitment to draw a line in the 6.7 sand. I am baffled by why they would do that, and will explore PBoC’s possible rationale in this piece.
In short, I am inclined to believe they set the fixing lower because of the G20 Meeting hosted in Chengdu, China. If that is the case, they are likely to breach the 6.7 level in the coming weeks (possibly this week).
Stability ahead of SDR inclusion
Last Wednesday, the Federal Reserve Bank of Dallas published a report questioning the suitability of yuan as a safe haven currency.
“Overall our findings do not support the suggestion that the renminbi is currently a safe haven currency and in that sense question the notion that the renminbi is progressing towards safe haven currency status. We find that the relative value of the renminbi vis-à-vis all traditional safe haven currency candidates decreases as market uncertainty increases.”
Could this have prompted the PBoC to stabilize the fixing? Maybe, but even so, I find little persuasion that PBoC will decide to take a pause for the next 3 months for something that has already been officiated. The report may prompt PBoC to stabilize the fixing for a few weeks, before resuming a depreciative trajectory of the USDCNY.
EM Contagion from Turkey
Another argument is that the PBoC wanted to stabilize the fixing before the crisis in Turkey spread to EM Asia. But even as markets shrugged off the crisis during the week, PBoC still set the fixing 54 pips lower on Friday. If this is true, then we will also see PBoC set the fixing higher in the coming days.
PBoC’s Standard Playbook…?
One other possible reasoning is that PBoC has a standard way of depreciating its currency – in predictable cycles. If we look at how the USDCNY has moved since Jan 2014, one can easily see certain characteristics in each cycle. Each depreciation cycle brought USDCNY around 3-4% higher, while stabilization retraced it by around 2%. Even though it takes a conspiracy theorist to believe this, I find myself rethinking about this possibility more than I should. Will the PBoC really take such a systematic approach to depreciate its currency? From a policy-setting standpoint, it would be arguably foolish thing to do. Further, if you look at each of the cycle, there has always been good reasons why PBoC stabilized the fixing – be it SDR’s political reasons, intensified capital outflows or market panic. I leave you to make a judgement on this.
G20 Meeting in Chengdu
Or perhaps PBoC simply does not want to breach the 6.7 level just yet before heading into the G20 meeting. After all, the 6.7 level holds dearly to many investors and speculators and breaching it a week before the meeting may attract unnecessary attention. Governor Zhou Xiaochuan knows this, and he wants to avoid any uncomfortable confrontation from IMF or Japan. Logically speaking, I find this the most convincing, and if that is the case, the PBoC may continue to set its fixing higher in the coming weeks.
No Trade: What’s the rush, really?
While I thought long and hard about putting on a long USDCNH trade, the risk-reward ratio isn’t favorable, in my opinion. Given recent good data (GDP, retail sales and industrial output all beat expectations 2 weeks ago), there is really no hurry for PBoC to continue bringing the CFETS Index down, especially after a relatively sharp depreciation since 23 June. PBoC can afford to be in a wait-and-see mode. As such, I’d stay away from the trade for now, but will continue monitoring the fixing closely for any faltering signs of this 6.7 commitment.
Best,
Perry
Disclaimer: Perry is a summer analyst at JP Morgan. This is his personal view.
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