With the Yuan having traded within fractions of what many consider a key psychological level for the USDCNY at 6.70, many traders expected that following the just concluded G-20 meeting in China, the PBOC would finally relent in its devaluation defense, and let the currency slide on through to the other side. Not only did that not happen, but overnight the Chinese Central bank unleashed one of the most furious attacks on currency Yuan shorts since the January devaluation scare when the cost of borrowing yuan in Hong Kong soared to a seven-month high amid.
The overnight HIBOR, or Hong Kong Interbank Offered Rate, jumped - seemingly without reason - by 3.88% points to 5.45%, the most expensive since February, according to Treasury Markets Association data. Other tenors joined with the one-week rate rose 2.09% points to 4.06%.
As Bloomberg confirms, the PBOC "may have tightened liquidity in the offshore yuan market to control declines following speculation that it would allow depreciation now that a Group of 20 summit is over, according to Mizuho Bank Ltd. The monetary authority drove offshore yuan borrowing costs to unprecedented levels in January in an effort to punish bears."
Ken Cheung, an FX strategist at Mizuho Bank, said that “everyone was talking about depreciation after the G20 meeting, and China could be reacting to that." To be sure, the monetary authority was aware of the coming short attack as well, and simply preempted it by making costs of borrowing prohibitively expensive. As Ken adds, "the authorities may be repeating January’s trick - tighten liquidity and crack down on bearish speculation on the yuan."
The mechanics of the move, used often in January and February when the Yuan was seemingly sliding every day, are as follows (courtesy of Bloomberg): China’s central bank influences funding costs in Hong Kong by encouraging state-owned banks to hold back from loaning their excess yuan. A surge in yuan Hibor hurts bears in two ways: by increasing the cost to borrow the currency and sell it, and also by prompting lenders that want to avoid paying the higher rates to buy the yuan they need in the spot market instead, bolstering the exchange rate.
It is unclear if the PBOC's move, which to some smells of desperation, will have a long-lasting effect: the offshore yuan has dropped 0.6% versus the dollar since the start of August as Chinese data failed to quell concerns over the nation’s economic health and the Federal Reserve indicated it could raise borrowing costs this year. Furthermore, some banks such as JPM have voiced a certainly that China will cut rates by at least 25 bps in the coming months - a move which would further weaken the currency. As a result, depreciation bets have resurfaced in the derivatives market, with a three-month measure of expected yuan price swings surging the most since January last month. The offsetting good news, as reported this morning, is that the weaker yuan helped Chinese exports drop less than expected in August.
Meanwhile, the bogeyman for China, capital outflows, continue, and as China reported on Wednesday, the latest foreign reserve total dipped by $16 billion to $3.185 trillion.
While capital outflows have eased from record levels last year, firms and individuals still appear uncomfortable with exposure to China’s currency. A Bloomberg gauge of local companies’ willingness to convert foreign currencies into yuan is near a record low, while an unprecedented overseas acquisition binge suggests strong demand for exposure to foreign assets. A net $55 billion flowed out of China in July, compared with $49 billion in the previous month, according to calculations by Goldman Sachs.
Yet as outflows have persisted, the Yuan has done very little in recent months, which has spurred speculation that China’s central bank was propping up the exchange rate to deflect criticism of its policies during the G20 meeting, and that it would allow depreciation before the yuan’s entry into the International Monetary Fund’s reserves on Oct. 1. It appears that the PBOC was eager to not only reject such speculation, but to crush any news Yuan shorts.
Confirming that there was a directed intervention aimed at punishing shorts, Bloomberg adds, that the gap between overnight forwards and the spot rate in Hong Kong, so-called forward points, jumped to 20, the highest since February. The increase suggests the yuan’s supply was squeezed, according to Zhou Hao, an economist at Commerzbank AG in Singapore. The offshore currency rose to as high as 6.6637 per dollar before weakening 0.02 percent to 6.6725.
"The authorities could be trying to dry up liquidity in the offshore market in order to reduce bearish bets, as the exchange rate approached the sensitive level of 6.7 a dollar earlier," said Banny Lam, head of research at CEB International Investment Ltd. in Hong Kong. "There’s still very strong expectation for the yuan to depreciate."
For now the PBOC has won the battle, however it will likely lose the war: as Frances Cheung, head of rates for Asia ex-Japan at SocGen told Bloomberg, "front-end forward points coming off earlier highs suggests the squeeze could be temporary. The less flush offshore yuan liquidity conditions - as various flows subside - could amplify the movement in front-end rates should there be a sudden need for liquidity."
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Meanwhile, just as the PBOC intervened in the FX market, a new leak sprung in a totall different place: just as the central bank was squeezing Yuan shorts in Hong Kong, Bitcoin soared higher by another 3%, driven by a surge in buying on the Chinese Huobi exchange, sending the price for the digital currency back to a 1 month high.
As we first reported over a year ago, when it was trading at $230, bitcoin has become the "capital outflow alternative" of choice for numerous Chinese, and based on historical patterns, any time Chinese capital outflows spike, or the PBOC engages aggressively in preventing these, the price of bitcoin jumps, just as it did overnight.
Going forward the PBOC may be forced to intervene not only in the spot FX markets but also to short BTC as the local population gets increasingly creative in finding ways to bypass China's great monetary firewall.