As we observed earlier, China’s currency gained 0.5% in offshore market to 6.8275 vs dollar, earlier surging as high as 6.78, extending its 2-day advance to 2%, the most on record, driven by a direct attack by the PBOC on shorts, whom it crushed overnight when it pushed the overnight offshore Yuan deposit rate to 80%, the highest in history.
The epic squeeze took place almost a year after an identical moves a year ago: back then the abrupt market reversal almost exactly a year ago marked the beginning of a nearly 5 percent rally that lasted two months.
Traders responded with deja vu shock: “Another extraordinary day in China,” said Gareth Berry, a foreign-exchange and rates strategist at Macquarie Bank Ltd. in Singapore. “It looks like a classic case of a consensus trade blowing up at the start of a new year.”
"It’s painful to sit on short yuan positions now, given the soaring funding costs," said Sim Moh Siong, a currency strategist at Bank of Singapore Ltd.
Did the PBOC intervene? Most likely. As Bloomberg reported, "Judging from the speed of the yuan’s appreciation, the PBOC may have intervened to prop up the exchange rate," said Kenix Lai, a Hong Kong-based foreign-exchange analyst at Bank of East Asia Ltd. "The PBOC is expressing its strong determination to keep the currency stable and is seeking to restore confidence.”
However, for every such intervention there is an offsetting cost. While surging interbank rates help deter bearish speculators, they also undermine China’s push to make the yuan an international reserve currency, said Michael Every, head of financial markets research at Rabobank Group in Hong Kong.
“What’s the point of being a reserve currency and having fought so hard to become a reserve currency, and then not letting anybody get hold of that currency,” he said. “China basically wants to have its cake and eat it on all fronts.”
They also lead to a freeze in interbank liquidity, and should any bank find itself in urgent need of cash, it is out of luck.
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Finally, to demonstrate just how unprecedented the PBOC intervention, here is a recap of the amazed reactions by various members of the sellside. Below is a representative sample of what some of the world's top strategist thought of the PBOC's shocking overnight move.
Bank of Singapore (Sim Moh Siong, currency strategist)
- CNH saw a “bear stampede” due to a position shakeup that was partially driven by a “self-reinforcing” pullback of dollar strength vs G10 currencies and yuan
- It’s “painful to sit” on short yuan positions now, given the soaring CNH funding cost
- Offshore yuan could extend rally to 6.75 per dollar in near term as there’s still a lot of short yuan positions under pressure to unwind
- China has kept CFETS basket relatively stable since July and recent bias of stronger fixings suggest yuan depreciation may have been excessive; in medium-term, however, currency still faces downward pressure due to fundamental factors
Rabobank (Michael Every, head of financial markets research)
- Capital controls aren’t working because that’s why they’re having to raise overnight deposit rate so aggressively; PBOC is still the guiding hand in CNH market, squeezing liquidity and forcing interest rates higher to “punish” anyone who’s borrowed CNH or shorted it
- It’s an incredibly aggressive tactic, completely disruptive to day-to-day activities on CNH and completely opposite to any underlying effort to try to internationalize the currency or to put it forward as alternative to other currencies in the region for any day-to-day business
- All of this is being done just to stop a few people shorting the currency to reflect the fact that everyone can see that capital is flowing out and that fundamentals argue for a weaker yuan
Bank of East Asia (Kenix Lai, FX analyst)
- Given speed of yuan’s move, PBOC may have intervened to prop up exchange rate
- PBOC is expressing its strong determination to keep currency stable and is seeking to restore confidence, as reset of citizens’ $50,000 quota of foreign-currency purchases and falling reserves weigh on sentiment
Mizuho Bank (Ken Cheung, Asian FX strategist)
- Traders started unwinding long dollar and short yuan positions, and selloff doesn’t seem be related to intervention judging from flows
- Some hedge funds, which have accumulated big short-yuan positions, can no longer bear the carry cost and losses
NAB (Christy Tan, head of markets strategy)
- CNH rally came on the back of further short-covering, which in turn, pulled up CNY; offshore yuan’s movements are leading onshore yuan’s
- It’s probably a reflection of “herd behavior” and of recent dollar weakness
- Wide spread between offshore and onshore exchange rates may have added to strong pull for onshore yuan
Standard Chartered (Eddie Cheung, Asia FX strategist)
- Removal of yuan liquidity has led to short squeeze in offshore interest rates; combined with higher fixings, this has caused market participants to pare back on positions that were looking for repeat of early 2016
Shanghai Commercial Bank (Ryan Lam, head of research)
- Chinese banks in HK aren’t actively offering yuan liquidity in offshore market today; yuan liquidity is unlikely to improve due to increasing demand from traders seeking to unwind short positions, unless Chinese banks start to offer yuan
- Chance for arbitrage is slim; Chinese banks have been checking cross-border flows very carefully lately and it’s very hard to move funds out without real trade- based documents; also, foreign banks in China have become conservative after the authorities checked some of them last year
China Everbright Bank (Ngan Kim Man, deputy head of treasury)
- It’s very likely that Chinese authorities are withholding cash; these couple of days have been like a repeat of last January
- There’s been a lot of attention on psychologically important level of 7, so China may want to maintain order around this time
- It seems that China’s priority for now is preserving its foreign-exchange reserves; this is a stockpile to preserve its exchange-rate regime; if this drops too quickly, FX stability will be affected