And now, Trump finally has reason to be angry with China for intervening in its currency to manipulate it lower, not higher.
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After the biggest weekly surge in the Yuan on record, the first sign that Beijing had had enough of the relentless surge in the currency was unveiled overnight, when according to a Reuters report quoting "policy insiders" China had "begun to worry about a rallying yuan as exporters come under strain" a sign the currency’s gains might lose steam after it hit a two-year against the dollar just weeks before Beijing is set to host a crucial Communist Party gathering in the autumn.
For those who have not been following our daily morning update on the Yuan, here is how sharp the move has been in recent weeks, and how painful to countless Yuan shorts who have been left with massive margin losses.
In a rapid turn in fortunes after last year’s slide, the yuan’s sharp rebound since May has presented a fresh headache for authorities as Chinese exporters are suddenly facing the same pressure as their European peers (where the 1.20 line in the EURUSD has proven to be a "red line" for the ECB, beyond which exporter profits are expected to tumble). However, intervening to cap the Yuan could expose China to accusations of currency manipulation by U.S President Donald Trump, effectively tying the PBOC's hands.
“Appreciation is better than deprecation, but the pace of appreciation cannot be too fast, otherwise it will be unfavourable for domestic firms,” a policy insider told Reuters.
The rally has been spurred by the dollar’s broad decline, optimism about the economy, a crackdown on capital outflows, and more recently the central bank’s tighter control of the mid-point, from which the yuan can rise or fall 2 percent.0
The yuan has gained nearly 7.8 percent against the dollar so far this year, including just over 6 percent since late May, more than making up its losses of 6.5 percent in 2016 - the biggest annual drop since 1994.
The surge in the Yuan, coupled with a plunge in the dollar, accelerated dramatically overnight as we observed, leaving many worred about the disruption to the economy ahead of the Communist Party Congress in October, where President Xi Jinping hopes to strengthen and extend his leadership of the party, should it remain unchecked.
“It could be disastrous if the yuan rises sharply,” said another policy adviser, one of the four sources involved in internal policy discussions but are not part of the final decision-making process.
“The economy has just showed some improvement due to a stronger global economy,” the adviser said.
Confirming the Reuters report, one policy insider said commerce ministry officials - staunch advocates for exporters - had expressed concerns over the yuan’s surge. And yet, as noted above, authorities were said to be unlikely to intervene forcefully to weaken the yuan for fear of sparking fresh criticism over its currency practices from the United States.
The U.S. Treasury releases its next report on currency practices of trading partners in October. In April, it said the test for Beijing would be how they handled a strengthening yuan, leaving China in a bit of bind on how to respond to a rallying currency without raising Washington’s ire.
“China will need to demonstrate that its lack of intervention to resist appreciation over the last three years represents a durable policy shift by letting the (yuan) rise with market forces once appreciation pressures resume,” the Treasury said.
Furthermore, signs that the PBOC had had enough with the Yuan's appreciation emerged even before the Reuters reports, when traders began to suspect the central bank was starting to signal a desire for the rally to moderate when on Friday, the central bank raised its official yuan midpoint for the 10th straight session - but it was much weaker than market expectations.
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Fast forward to today, when the PBOC appears to have found a brilliant solution to both problems, when as Bloomberg reported that China’s central bank would remove a reserve requirement for financial institutions trading in FX forwards for clients by cutting it to zero from 20% currently. The change will take effect on September 11.
As a reminder, banks, funds and other financial institutions trading FX forwards for clients were required from October 2015 to set aside 20% of the past months’ sales as reserves in a move that was aimed at curbing currency speculation. Subsequently, the PBOC further punished traders, or rather shorts, by boosting short-term margin requirements on FX positions, making it virtually impossible to hold on to a short position for a long period of time.
So what happened today? Well, the PBOC has just U-turned, and has given a greenlight to the same FX speculators whom it criticized (remember the Chinese anti-Soros media campaign), slammed, punished, and in some cases arrested, to now short the Yuan once more.
On the surface, this is a brilliant solution to Beijing's problems: it lowers the Yuan on one hand, and on the other, it's not the PBOC who is manipulating the currency, it's the evil speculators who are "guilty."
In number, the PBOC "reserve release" would remove substantial fwd hedging demand: according to some calculations, if the forward hedging ratio goes back to its historical average level of 12% from the current 5%, it would result in an addition $10BN/month in USD demand, potentially sending the yuan back above 6.60
But most importantly, the removal of this marginal capital control is immediately working, as the following intraday chart of the USDCNH clearly shows.
Now the question, of course, is how long will the PBOC allow this move to continue before it once again pulls out the rug from under the "speculators" feet with a well-timed FX margin hike to 100% or more, crushing all shorts, and reseting the cycle.