(Bloomberg) — China stuck to a holding pattern of supporting the yuan as pressure from a resilient dollar and poor sentiment weakens it toward a policy red line.
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The People’s Bank of China set the daily reference rate for the managed currency at 7.0947 per dollar, broadly near the last fixing level, implying that stability is key. China manages its currency onshore by setting a daily reference rate against the dollar at 9:15 a.m. local time, around which it is then permitted to trade in a 2% range.
Traders have been eyeing the so-called fixing for signs of where Beijing wants to guide the yuan after it weakened to within a whisker of that trading range last week. China’s policymakers have been vigilant of currency pressure which can spill over to local stocks and bonds, despite the fact that the country’s export engine would benefit from a weaker yuan.
“Spot may continue to trade near the 2% cap intraday,” said Frances Cheung, strategist at Oversea-Chinese Banking Corp. “The PBOC may have strong intention to defend the level at this juncture.”
Recent resilience in the dollar — a result of bets that the Federal Reserve will keep its policy rates higher for longer — is making the PBOC’s mandate of steadying the yuan even more difficult. The currency has also come under pressure as investors sour on the prospects for China’s economic growth.
Stability tends to be prized because rapid yuan drops can also lead to a vicious cycle of capital outflows and exacerbated losses. As a regional currency anchor, any message which triggers yuan volatility can quickly spill over into other markets.
The yuan traded little changed after the steady fixing.
Red Line
The PBOC has stepped in aggressively to stabilize the yuan on each of the five occasions it neared its policy red line in past years. It has adopted tools ranging from verbal warnings to boosting the cost of short wagers against the currency.
The yuan has never moved outside of its permitted range in history. So there is little guidance on what may happen to China’s spot market if the currency tries to touch the weak end this time around.
What’s more certain is that investors will likely see trading disruptions, with some transactions not being able to go through. That’s based on what happened in a corner of the spot market last week, when traders weren’t able to execute some trades as the yuan neared the weak end of the band.
“I think the pressure is rising for an increase in volatility for both fixing and spot and it’s increasingly difficult for the PBOC to draw a hard line here if the dollar continues to strengthen,” said Xiaojia Zhi head of research at Credit Agricole CIB. “That said, the PBOC would remain mindful to manage the expectations.”
–With assistance from Ran Li, Iris Ouyang and Wenjin Lv.
(Updates with additional context)
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