One of the key things to understand about China’s attempt to mark a managed transition to a new currency regime (i.e. a devaluation completely on the PBoC’s terms) is that it comes at a dramatic cost to liquidity. Although the devaluation was widely billed as a transition towards a more market-based regime, all Beijing actually did was change what it was manipulating. As BNP pointed out last month, whereas China used to manipulate the fix to control the spot, now they simply manipulate the spot to control the fix, meaning that as long as there’s significant pressure on the yuan, the new system will require more central bank meddling, not less. This manifests itself in the selling of USD reserves and as we noted when we tallied up [6] the three month UST liquidation total last week, these interventions had totaled nearly $50 billion in September by mid-month. Adding to the burden, the PBoC is also intervening in the offshore yuan market in order to close the spread between the onshore and offshore spots. Here’s what we said about that latest spinning plate:
Note the rationale here. This is China intervening in the hopes that said intervention will make further intervention unnecessary. That is, rampant speculation that the yuan will continue to depreciate is forcing the PBoC to intervene in the onshore market and at an extremely high cost both in terms of the country's FX reserves and in terms of the deleterious effect the reserve liquidation has on liquidity. Devaluation expectations are at least partly manifesting themselves in the offshore spot market so ultimately, the PBoC figures it will try intervening there in the hopes that narrowing the spread will mean it has to intervene less in the onshore market. Summarizing the above in four words: one more spinning plate.
Of the $50 billion SocGen suggested the PBoC had spent in September on FX interventions, some $25 billion was spent shoring up CNH. Of course these interventions are sucking liquidity out of the market and on the mainland, they’re working at cross purposes with the PBoC’s easing efforts. On Tuesday, we got what looks like evidence that ham-fisted CNH intervention is causing yuan money markets to tighten dramatically in Hong Kong. Consider the following from WSJ [7]:
In a fresh sign of intervention offshore, the yuan abruptly strengthened to 6.34 against the dollar late Tuesday in Asia. For most of the day, the currency had been relatively calm, hovering around 6.36 to the dollar for most of the day after strengthening from roughly 6.4 per dollar last Friday.
“Chinese banks have been buying [the yuan] aggressively this evening,” said one senior trader at a major local bank.
Earlier Tuesday, the overnight rate that banks in Hong Kong charge each other to borrow the yuan jumped to 8.73% from 3.38% Friday, according to the offshore fixing rate—a benchmark based on reference rates contributed by local banks and compiled by the Treasury Markets Association, the city’s banking industry group.
Hong Kong’s markets, which constitute China’s biggest offshore yuan hub, were closed Monday and will be closed Thursday for holiday.
The liquidity squeeze has been the worst since the end of last month, when the overnight borrowing rate for offshore yuan hit as high as 20% amid a heavy selloff in dim-sum bonds—yuan-denominated securities mainly traded in Hong Kong—since investors realized yuan assets are no longer a sure bet.
Here's CNY/CNH shown over the longer term and intraday (note the spread shown in the lower pane of the two year chart):
[8]
[9]
And here's the effect on money markets:
[10]
The takeaway is that the holiday effect notwithstanding, the offshore intervention effort looks to have just shown up in HIBOR which makes us wonder how much longer it's going to be before something finally snaps here:
[11]
