From Zero Hedge
For the first time in almost 3 years, the 'market' is fighting the PBOC in the FX markets. The last month has seen USDCNY rise almost 9 handles to as high as 6.21 (the weakest CNY in 5 months). At the same time, the PBOC's official 'fix' of CNY has been strengthened to below 6.12 (the strongest CNY in 9-months) diverging by the most in six months from the market. "The market is staying cautious and even bearish on the China macro outlook," notes Morgan Stanley, but as HSBC explains, "China doesn't want to join the currency wars [and wants to stall any speculation on trend] and that explains the fix movement." Simply put, markets doubt the PBOC and believe it will eventually be dragged into the currency war or just fundamentally deteriorate enough to warrant capital flight.
The lower pane shows the divergence between the CNY weakness in the market rate and strength in the Fix...
A battle in China’s currency markets has emerged in recent days with traders pushing the yuan weaker while the central bank has been attempting to guide the tightly-controlled foreign-exchange rate stronger.
That tension was on show Wednesday when the yuan opened 1.1% weaker from where the central bank fixed the morning reference rate, the biggest drop since June.
The slide of the currency accelerated in December after the central bank cut interest rates in November, leaving it 2% weaker for the year so far and on track for its first annual loss since 2009.
Investors have been focusing on an almost daily deluge of weak data out of China with reports this week showing inflation softened to a five-year low in November while the country’s exports fell well below expectations in the same period. A broadly stronger dollar on the back of a recovering U.S. economy has also hurt sentiment on the yuan.
The volatility picked up this week after Beijing curbed risky lending in the bond markets, sparking heavy declines in the stock and bond markets Tuesday and a record two-day tumble in the yuan.
But China’s central bank has been fighting the market, setting the yuan’s reference exchange rate, or “fix,” stronger against the dollar. The currency’s daily trading is limited to a 2% band above or below this “central parity” rate.
Analysts say Beijing is eager to prevent one-way speculation on the currency and squeeze out those betting on the currency to decline further.
“China doesn’t want to join the currency wars and that explains the fix movement,” said Ju Wang, a currency strategist at HSBC in Hong Kong, referring to some country’s efforts to push their currencies lower to stay competitive against one another. “But markets see it as China will eventually be dragged into the currency war or just fundamentally, growth and exports will weaken so much that will trigger the markets demand for the U.S. dollar.”
With a broadly stronger U.S. dollar since July this year and diverging monetary policies between the U.S. Federal Reserve and the central banks of Japan and Europe, currencies across the board have suffered significant losses, especially the Japanese yen, creating competitive challenges for many economies.
Analysts also point to China’s balance of payments data that in recent quarters has shown falling trade financing and short-term loans as possible evidence of outflows of speculative money, also pressuring the currency weaker.
Plus, as the difference in interest rates between the U.S. and China narrows and the returns on a higher-yielding currency fall, the yuan is expected to adjust to a weaker level.
“The market is staying cautious and even bearish on the China macro outlook,” analysts from Morgan Stanley wrote in a note. The currency market “is the most liquid market to express such a concern.”
To add to the pressure, the Bank of International Settlements in a report released Sunday noted China had become the largest emerging market borrower, with outstanding cross-border claims on China totaling $1.1 trillion at the end of June this year.
“Concern at growing debt levels in China are only compounded by the BIS data. Combine that with fears over the slowing of activity and investor caution toward Chinese assets and the [yuan] has its validation,” Patrick Bennett, currency strategist at CIBC World Markets wrote in note.
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We suspect this will end badly as the pBOC changes some rules ad hoc and squeezes the trend chasers...