China Gets Creative, Turns To Swaps To Manage Yuan

Managing markets is hard - especially when you’re doing it on a daily basis while attempting to maintain some semblance of credibility in the face of accusations that, even in a centrally planned world, your particular brand of interventions are so egregious as to stray outside the bounds of manipulated market decorum.

That’s the rather precarious situation that China finds itself in while trying to manage a yuan devaluation that, on the surface anyway, was supposed to represent a move towards liberalization but in fact is requiring more intervention than ever and now threatens to drain the world’s largest store of FX reserves while simultaneously sucking liquidity from the market and working at cross purposes with multiple policy rate cuts. 

In situations like these, sometimes you have to get creative which is why we weren’t entirely surprised on Thursday when trader chatter indicated that at least one big Chinese bank (on behalf of the PBoC of course) was stomping around in the onshore swaps market and indeed, as you can see from the following chart, there's something odd going on here, and although we can't reconcile their numbers, we have included some commentary from WSJ as well.

From WSJ:

The People’s Bank of China intervened in the market for U.S. dollar-yuan foreign-exchange swaps, causing their price to fall sharply, a movement that implies a stronger Chinese currency and lower interest rates in the world’s No. 2 economy in the future, said the people.

 

Thanks to what each of the three people described as “massive” orders from a few commercial banks acting on the PBOC’s behalf, the so-called one-year dollar-yuan swap spread—in rough terms, a measure of the implied future differential between Chinese and U.S. interest rates—plunged to 1200 points from 1730 points Wednesday.

 

In the offshore market, the spread dropped to 1950 points from 2310 points Tuesday, following the onshore move.

 

A drop in the spread for dollar-yuan swaps, which consist of a spot trade and an offsetting forward transaction, would also imply a weaker spot exchange rate at a predetermined future date.

 

“The central bank chose a rarely used tool this time—the FX swaps—to intervene and it did so via a couple of midsize banks, instead of the usual big state lenders that serve as its agent banks,” one of the people said.

 

“In a way, it’s more effective for the central bank to manage people’s outlook of the yuan in the swap market due to the latter’s forward-looking nature,” said one of the people. “It’s likely partly in response to aggressive yuan selloffs in the offshore market.”