THE onshore yuan is set to end a miserable month and things could get even worse for its less-regulated offshore exchange rate as China goes on a one-week holiday.
The currency traded in Shanghai is on track for a seventh month of losses, matching a record run during the height of the US-China trade war four years ago. Historical volatility for the yuan in the past week spiked to a level unseen since 2020 as the exchange rate gets caught between two opposing forces: a surge in the dollar and Beijing’s attempts to clamp down on speculation.
The drama may only worsen next week, as the offshore yuan — which is subject to less control by the central bank — loses an important anchor. With mainland markets closed for the Golden Week holidays starting Saturday, Beijing will not be able to guide investor expectations with its daily reference rate.
The offshore yuan — which started trading in 2010 — isn’t subject to the onshore currency’s trading band, which limits moves to 2% in either direction from a reference rate set each morning by the central bank. That makes the overseas yuan even more vulnerable to the dollar’s relentless rally that has pummeled currencies across the world, including the Japanese yen and the British pound.
China’s central bank appears to be girding itself for any disorderly trading next week. The People’s Bank of China asked major state-owned banks to be ready to sell dollars to prop up the yuan overseas, Reuters reported citing people with knowledge of the matter. Beijing also issued a strongly-worded statement on Wednesday to deter speculators, warning them that they’re bound to lose money in the long term. The onshore yuan gained for the first time in nine sessions on Thursday.
“The PBOC is trying to bring some stability to the market, but the problem is that the dollar is too strong,” said Geoffrey Yu, senior FX strategist at Bank of New York Mellon. “If the US data remains strong, there’s not much central banks can do to stop the dollar rally.”
The yuan’s outlook remains bleak despite Thursday’s rebound. China’s monetary policy is diverging further from the US, driving outflows. While the Federal Reserve retains a hawkish stance in its efforts to curb US inflation, Beijing is keeping an accommodative policy amid signs the Asian economy is cooling due to Covid lockdowns and a housing-market crisis.
Bearishness prevails in the derivatives market. Traders added the most short yuan options this month so far this year, with the nominal value of bearish wagers standing at about four times the size of bullish bets, Bloomberg-compiled data show. Three-month risk reversals, which measure the cost of hedging against offshore yuan losses, jumped to the highest since May this week.
“Sometimes it helps to send a signal that you think the move has gone far enough, even if in the coming weeks, it goes further,” said Kit Juckes, Societe Generale SA’s chief foreign-exchange strategist in London. “It’s hard to see the dollar peaking until 10-year Treasuries, say, peak convincingly and we can see an end to Fed tightening.”
The central bank has set stronger-than-expected yuan fixings for 26 straight sessions, the longest streak on record since Bloomberg started the survey in 2018. Earlier this week it imposed a risk reserve requirement of 20% on currency forward sales by banks to make it more expensive to short the yuan. That’s after a move to reduce the foreign-currency reserve requirements for banks.
The offshore yuan will remain at the mercy of the dollar in the coming week, said Tommy Xie, an economist at Oversea-Chinese Banking Corp. in Singapore. The currency that trades in Shanghai may retest 7.25 per dollar into next year.
“It is not really the yuan’s fault,” he said. “The dollar is simply too strong.” – BLOOMBERG