Tags: China | Yuan | Speculators | currency

As China Eases Grip on Yuan, Ground Shifts for Speculators

Monday, 26 March 2012 11:32 AM

For players in China's tightly corseted currency market, the authorities' loosening of the strings this month to allow wider yuan moves has boosted both opportunities for short-term profit, as volatility rises, and long-term risks, with yuan appreciation no longer a certainty.

The People's Bank of China (PBOC) in March has made yuan trading more of a two-way street than ever before, with relatively hefty day-to-day losses as well as gains, testing how the market will value the yuan as authorities gradually nudge their currency toward a free float and global status.

China's leaders appear to be growing confident that, with the yuan up 30 percent against the dollar since its landmark 2005 revaluation, and with the trade surplus shrinking and actually shifting into its biggest deficit in at least a decade in February, the currency is approaching fair value.

This creates a whole new ball game for traders and investors long accustomed to a yuan market that only goes one way - up - and has done so in a gradual, orderly fashion.

"There are clearly both business opportunities and risks if the yuan is trading in a wider range," said Wang Haoyu, economist at First Capital Securities in Shenzhen.

"The rare trade deficit in February relieved pressure on the yuan to appreciate and presented a good opportunity to test the waters for reform."

In the domestic market, one result of the new volatility has been dollar buying by banks and corporations for short-term speculation, never seen before when the dollar mainly moved lower against the yuan.

More volatility also boosts potential profits, making it worthwhile to jump in for short-term speculators, and especially for astute PBOC-watchers in a market where the central bank still exerts substantial influence.

Offshore, some traders say short-term forwards of three months or less are now preferred for speculative plays, while contracts above six months are used increasingly for hedging purposes, as uncertainty mounts about the long-term trend.

Most traders still believe the yuan will appreciate this year, despite a decline of 0.2 percent so far since Jan. 1, as exports are expected to rebound somewhat, but the full-year rise is likely to be much less than last year's 4.7 percent.

Moreover, as the spot yuan market in the mainland gains more freedom of movement, values are coming more closely into line with the overseas Hong Kong market, traders said. The spread between the two has narrowed to less than one-10th what it was in January and barely one-30th the divergence last September.

These developments feed into China's aim to steadily deepen and develop the yuan market, and eventually make the yuan a freely traded international currency, although comments last week by Chinese Premier Wen Jiabao maintained the government's vague stance on when that might happen.


The yuan volatility this month has been unprecedented in the 18-year history of the domestic currency market.

In the first half of March, the PBOC's daily midpoint, the base rate indicating government intentions on currency values, saw a 0.7 percent drop in the yuan against the dollar, the biggest 11-session loss since the domestic market's launch.

Over the next seven sessions up to Monday, the fixing's yuan value rose 0.8 percent, the biggest seven-session gain in more than seven months.

The dollar/yuan spot rate can rise or fall 0.5 percent on any given day against the midpoint, which the PBOC says is set while taking market activity into account.

A Reuters poll this month showed that analysts and economists believe China could double the daily trading band as soon as the second quarter, given the authorities' latest moves to let the currency trade in a wider range.

"The yuan's volatility this month is unprecedented and has caught us quite unprepared," said a trader at a Chinese state-owned bank in Beijing.

"Still, these bigger fluctuations in exchange rates over a few days or weeks raise the possibility of buying dollars for speculation - a tactic we couldn't even think about in the past due to the tight trading range."

A trader at a Chinese bank in Hong Kong said banks also appeared to have started doing more hedging of longer-term risk in the yuan's future value, rather than focusing on speculation.

Since the establishment of Hong Kong's CNH yuan market in 2010, corporate flows, particularly hedging activity, have been partially diverted there from the dollar/yuan non-deliverable forwards (NDFs) market.

NDF volumes have remained constant at about $4 billion a day but most of that is now concentrated in speculation at the short end of the NDF curve. A more volatile yuan will reinforce that trend.

"There are conflicting signals coming from the mainland on the extent of the slowdown in yuan appreciation this year and how comfortable authorities are (with continued appreciation)," said the head of foreign exchange trading at a European Bank in Hong Kong.

"Moreover, the consensus (among NDF traders) is for a maximum of 1-2 percent in RMB (renminbi, or yuan) gains this year. If that is so, there is no percentage in playing this market for now."

A trader at a U.S. bank said Hong Kong's CNH market was now closely following the mainland's CNY market, and he expected volatility would continue for the rest of the year.

"We trade very short-term now, say one-week contracts."

© 2019 Thomson/Reuters. All rights reserved.

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Monday, 26 March 2012 11:32 AM
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