Courtesy of Also Sprach Analyst.
Recently, the Chinese yuan has stopped strengthening against the US dollar. Indeed, it has been weakening, as I predicted it would.
What’s interesting when we look at the prices for USDCNY at daily closing and the People’s Bank of China daily fixing is that, increasingly, the Chinese yuan is closing at rates much weaker than PBOC’s fixing against the US dollar. That is to say that the PBOC fixes the exchange rate at a relatively strong level, and the market sells off yuan to a weaker level. The net result is that while the yuan has been weakening, nothing particularly dramatic has happened.
The chart below shows the gradual weakening of the yuan against the dollar. Note that the daily closing for the yuan is now consistently weaker than the PBOC’s fixing:
The chart below shows two things. The red line is the difference between PBOC fixing and the closing price of the previous day. The blue line is the difference between the closing price and the PBOC fixing of the same day. Increasingly, the PBOC sets the yuan at a stronger rate than the previous day closing, while the closing price turns out to be weaker than the PBOC fixing. In other words, the PBOC has been setting yuan consistently above the market price.
Yuan weakness is also manifested in the offshore market in Hong Kong, with the rate known as USDCNH. The Yuan was consistently traded at a premium in the offshore market compared to onshore yuan until September of last year when it was suddenly being traded at a discount as the euro crisis escalated around that time. The discount disappeared late last year, but offshore yuan is again being traded at a discount.
I speculate that because China is under increasing pressure of capital outflow (and because corporate China is short US dollars), the selling pressure on the yuan is increasing. However, it has always been dangerous for any central bank with an existing currency peg to signal to the market that it is allowing its currency to weaken (although we believe the PBOC has already done so by widening the trading band) because that tends to exacerbate the problem of capital outflow rather than stopping it. As a result, the PBOC appears to be signalling its desire to keep the exchange rate stable by setting the fixing higher than the market price, while the market is doing the rest.