BNY Mellon: Signs of Movement on CNY

26 okt 2018

By Simon Derrick, Chief Currency Strategist, BNY Mellon

Until the start of this week, there had been little sign that the NDF market was becoming particularly excited about the prospect of a significant move higher in USD/CNY, despite the recent slow steady rise in the USD.

To put this into some kind of context, by the middle of last week, the spread between the one-year NDF forward outright and spot stood at about the same level as it stood in October 2012 when the USD downtrend was starting to slow.

This suggested that the market collectively believed the People’s Bank of China (PBOC) would defend a “line in the sand” around the CNY 7 level. Comments over the summer from Guo Shuqing, Communist Party secretary of the PBOC, supported this view. 

This was curious for a number of reasons.

Firstly, with calls for a further stimulus growing in China, the need for easier monetary conditions would seem to favor the idea of allowing the CNY to weaken. Secondly, 2015 showed that the use of FX reserves in an aggressive defense of a currency is not without risk. Thirdly, this summer showed that there are points when the authorities are prepared to let the currency take the strain.

One reason why the market may have taken this view was a belief that Beijing would shy away from allowing anything to happen to the currency that could have fed through into broader market unrest. Certainly the evidence from 1998 and 2008 indicates that China has been prepared to hold the line on the CNY when market unrest has been evident. Nevertheless, given it was arguable that a smoothly managed depreciation in the CNY could prove more of a help than a hindrance, this still seemed odd.

Given this picture it seemed unsurprising that a news story emerged yesterday that indicated a slow and smoothly-managed appreciation in the USD beyond CNY 7 might be possible. MNI quoted Sheng Songcheng, a senior advisor to the PBOC , as telling them in an interview: "USD/CNY will not break 7 in the short term, but it is hard to say as of the end of this year." This seemed to build on other recent hints that managed decline was possible.

It is clear, however, that concerns remain. Comments overnight (see headlines) highlighted that Beijing is very keen both to avoid accusations of currency manipulation and to discourage speculators from mounting an attack on the currency (particularly the latter). The former is entirely understandable given the recent conversations that have taken place at the IMF and elsewhere while the latter is equally understandable in the light of what happened in early 2016.

What is also true is that the NDF market has begun to wake up to this possibility of a move higher for the USD with the six-month forward outright moving above CNY 7 for the first time since May of last year. Interestingly, the comments over the past few hours have done little to dampen this sentiment.

The question therefore is what actions the authorities take now to discourage too rapid a move lower in the CNY.