Overnight, China decided to take steps to reduce "macro financial risks."
And by that they mean "do something quick to help ease pressure on the yuan" and by extension, on the PBoC’s rapidly depleting FX reserves.
To that end, starting October 15 banks will have to hold the equivalent of 20% of clients' FX forward positions with the PBoC, where the money will sit, frozen, for a year, at 0% interest.
Obviously, that will drive up the cost of taking speculative positions which the PBoC hopes will help narrow the gap between onshore and offshore yuan and bring down volatility, although the degree to which this will help fill the CNY-CNH spread looks like an open question.
"It’s a move to ease the reduction in foreign-exchange reserves," Tommy Ong, managing director for treasury and markets at DBS Bank Hong Kong, tells Bloomberg. "It will also remove lots of speculative trades that aim at short-term gains as the reserves have a minimum lock-up period of one year," adds Stan Chart’s Becky Liu.
Here’s a bit of color from FX strategy desks via Bloomberg:
- Andy Ji, Singapore-based currency strategist at CBA:
- This is typical FX control, as it limits the FX forward positions
- PBOC has intervened before in the forward market, but imposing the 20% limit on outstanding forward position will require less intervention effort
- Spread on CNY and CNH may not substantially narrow on this move alone, as global demand on dollar remains high and China economic grow remains slow
- Fiona Lim, Singapore-based senior FX analyst at Maybank:
- This seems to be another move to discourage yuan forward selling and to lower yuan depreciation expectations
- Offshore-onshore yuan gap has been pretty persistent because of yuan depreciation expectations and officials want to narrow the gap
- Gap will be sustained as the economy continues to remain under pressure
- Becky Liu, senior Asia Rates strategist at Standard Chartered:
- Move aims to curb speculative onshore positions, anchor onshore forwards and hopefully eventually also bring down offshore forwards
- This move itself would reduce the need for PBOC to intervene in the onshore market
- Don’t think it will ease reduction in FX reserves; it basically is just making it a lot more costly to long USD in the onshore market
To the extent that the new currency regime ushered in on August 11 represented a "market-oriented" reform - and that characterization, as evidenced by daily FX interventions, is at best questionable - this move "is 10 steps back," one Hong Kong trader told Reuters, a suggestion that this isn't something the IMF will look favorably on when evaluating the yuan's SDR bid.
In any event, the bottom line is that this requirement will cost banks money, which means the cost of trading for clients will rise and that, China hopes, will translate into less pressure on the yuan and will thus help to curb the FX reserve burn. As we've seen with Chinese equity markets, the more draconian the measures the more likely it is that Beijing feels like it's losing control. As Credit Agricole puts it "while the introduction of reserve requirements for CNY forward trading overnight may help ease the selling pressure on the currency, the measure also reflects the fact that the markets did not really respond to the recent official attempts to prop up the CNY verbally." In the end, this doesn't alter any of the dynamics that are causing the depreciation pressure. Rather, it just punishes anyone looking to capitalize off those dynamics. Which we suppose is consistent with Beijing's general approach to dealing with problems.