China's unprecedented crackdown against Yuan shorts continued overnight, when the FX market saw even more fireworks as the onshore yuan headed for the biggest four-day advance since 2005 following the strongest central bank fixing since January and amid ongoing speculation China's central bank is trying to crush shorts while China's big banks continue to limit offshore liquidity.
The onshore Yuan rose 0.18% to 6.8062, extending the four-day gain to 1.2%, as of late trading in Shanghai. At one point in the session, the Yuan rose as much as 6.79, the most since July 2005, when China ended a peg to the dollar, according to Bloomberg. Earlier, the People’s Bank of China strengthens its reference rate by 0.79% to 6.8090 from 6.8633, the most since January. According to trader, the PBOC continues to use the fixing to guide the exchange rate higher, and both the onshore and offshore yuan will remain strong in the short term; Kenix Lai, an FX analyst at Bank of East Asia told Bloomberg that Thursday’s reference rate was stronger than what the bank’s model suggests. The gap between the onshore and offshore yuan rates narrowed modestly to 0.7%, after widening to 1% on Wednesday.
Meanwhile, the internals suggest that the move is not over as onshore yuan 12-month non-deliverable forwards gain for a seventh day, advancing 0.04% to 6.9785, while CNY 1-month volatility rises 8 basis points to 3.82%.
Separately, Bloomberg's replica of CFETS index, which tracks the yuan against 24 currencies, climbed 0.6% to 92.96, this was the biggest advance since the index was expanded.
The moves in the offshore markets were even more dramatic, with the CNH fluctuating between early gains and leading to subsequent losses; last trading 0.3% weaker at 6.76041 per dollar after earlier rising to a seven-month high. The impact of the PBOC's direct intervention meant the USD/CNH one-month risk-reversal options volatility fell to -0.1075, indicating options to sell the yuan against the dollar cost less than the options to buy: this was the first time this has happened since 2011.
In another notable move, the CNH tomorrow next forward points soared as much as 205 points to 290, the highest on record...
... however later in the session the move reversed direction to drop to 72.5. CNH 1-month forward points jump for a second day, rising 77.5 to 545
Similarly, after soaring earlier in the session, CNH overnight deposit rate ended up dropping 5 percentage points to 15%.
On the offshore liquidity front, the one-day CNH interbank rate in Hong Kong adds 21.74 percentage points to highest level since Jan. 6, according to fixing by Treasury Markets Association. One-week CNH Hibor advances 11.74 percentage points to 19.59633%; one-month rises to 10.57033%.
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Despite the ongoing fireworks, there was some good news for Yuan traders. In a note released overnight, UBS wrote that the CNY has appreciated notably against the USD in the past couple of days - a bit of an understatement - and added that "we see this as playing a bit of catching up following recent USD weakness. CNY has actually depreciated against the basket this year despite strengthening against the USD. Poor liquidity meant CNH moved up more. We now expect CNY to stay strong and not moving beyond 7 against USD this year."
More importantly, UBS said it expects the RMB to remain stable going forward. Here are the note highlights:
After a notable recovery in demand and corporate earnings, there are signs of the current mini-cycle peaking, although the slowdown has been very gradual and will likely remain so. We see property and credit as the two main forces that will lead to a slowdown in growth. That said, property starts and construction will likely lag sales by at least 6 months, which means property construction should remain resilient until year-end While we think overall credit growth may slow more notably than the official TSF growth would suggest (see Tightening on Shadow Credit and Implications; Deleveraging by Supervisory Tightening), any impact on the economy will likely also be delayed until Q4. As such, we maintain our 2017 GDP growth forecast of 6.7%, and expectations for Q4 to slow to 6.5%. The slowdown is expected to be more pronounced in 2018, when we see growth slowing to 6.2%.
We now see USDCNY not moving beyond 7 by end 2017 (versus 7.15 previously) and to remain relatively stable in 2018 – not moving beyond 7.1 by end of next year (from 7.3 previously). A weaker USD since the beginning of this year despite expected Fed tightening, tighter Chinese capital outflow controls, subsiding risks of a US-China trade war, and altered expectation towards USDCNY (partly helped by PBC adjustments to its CNY fixing strategy) are all important factors behind recent USDCNY stability. Going forward, UBS does not expect the USD to strengthen in 2018, and we expect controls on capital outflows to persist and political pressure on the CNY to stay. We also see limited upside for CNY – if and when the USD weakens further, we see the Chinese government limiting CNY appreciation (allowing for a bit of depreciation against the basket), so as to leave some room for USDCNY stability when the USD strengthens again.
Helped by exchange rate stability and controls on outflows, China's FX reserves will likely stay above $3 trillion in 2017. As USDCNY has stabilized, carry-trade or arbitrage activities by corporate and financial institutions have come down substantially – even through the underlying desire by Chinese corporates and households to diversify into foreign assets remain. Onshore FX purchase activity by households also seems to have calmed down. As a result, we now see China's FX reserves staying above $3 trillion in 2017, despite the fact that its current account surplus will likely shrink.