The yuan closed down against the dollar on Tuesday and scored its biggest monthly loss since its landmark July 2005 revaluation as the People's Bank of China set a surprisingly low mid-point, signaling its determination to halt the yuan's appreciation after its de-pegging in mid-June.
Dealers said that worries over a double dip recession in the global economy after weak data from particularly the United States and Japan, and recently tense Sino-U.S. political relations, appear to have contributed to China's decision to stop yuan appreciation.
The Chinese central bank may also be taking advantage of current global economic woes to weaken the yuan, letting the markets get more accustomed to yuan trading flexibility.
"The yuan appears to have fallen prey to politics again, and that makes forecasts of its near-term trend a difficult task," said a senior dealer at a major European bank in Shanghai.
"But one thing is certain: the PBOC is partly trying to break market expectations of non-stop yuan appreciation."
Most investors still believed the bottom line was that China would not allow the yuan to fall below 6.8262 against the dollar — the level before the PBOC announced a de-pegging of the two currencies on June 19, traders said.
The PBOC fixed the mid-point, or its daily reference rate against the dollar, at 6.8105 on Tuesday, down from Monday's 6.8025, guiding spot yuan to finish at 6.8074 from Monday's close of 6.8030.
Expectations that U.S. data this week will confirm the economy shed jobs in August kept investors at bay, sending the Dow Jones industrial average down 1.4 percent on Monday in the year's lightest volume.
Spats over issues from Internet freedoms to the Dalai Lama strained Sino-U.S. ties early this year. A $6.4 billion arms deal with Taiwan was a particular irritant. Beijing considers Taiwan a renegade province, to be reunited by force if necessary.
Military relations have been on ice ever since, with tension ratcheted up further recently by joint U.S.-South Korean naval exercises in waters near China's coast.
The yuan lost 0.48 percent against the dollar for August, its biggest monthly loss since Beijing revalued it in July 2005.
The yuan was little changed for more than a decade before the 2005 reform in which China shifted to "a managed floating exchange rate based on market supply and demand with reference to a basket of currencies", to replace a single exchange rate system solely decided by the central bank.
The reform was interrupted for nearly two years since July 2008 until mid-June this year during which China re-pegged the yuan to the dollar to help fight the global financial crisis.
After the resumption of the reform, the yuan rose as much as 0.91 percent on Aug. 9, to hit a post-revaluation high of 6.7644 to the dollar.
But the PBOC has since guided it lower and the yuan now stands only 0.28 percent higher since the de-pegging.
Offshore dollar/yuan forwards rose sharply on Tuesday to imply less yuan appreciation, reflecting the PBOC's weaker-than-expected mid-point.
"The bias is to buy USD/CNY NDFs with the fixings constantly coming up with new surprises," said a trader at a European bank in Singapore.
Benchmark one-year dollar/yuan non-deliverable forwards (NDFs) were bid at 6.7160 late on Tuesday from 6.7000 at Monday's close, with their implied 12-month yuan appreciation falling to 1.41 percent from 1.53 percent.
As the yuan appears increasingly unlikely to appreciate sharply any time soon, some activity in NDFs is also diverted into Hong Kong's yuan deliverable forwards after China in recent months opened alternatives for the use of yuan outside its borders, traders said.
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