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China's yuan firms as PBOC sets stronger midpoint

[HONG KONG] China's yuan rose against the dollar on Monday after the central bank set the strongest official midpoint in a month to reflect a softer US dollar.

The People's Bank of China fixed the midpoint rate at 6.1448 per dollar prior to market open, firmer than the previous fix 6.1496. It was the strongest level since Feb 26.

The dollar started trade in Asia on the defensive, after a volatile few days in the wake of the Federal Reserve's dovish steer, which cast doubts on bullish positions in the greenback.

Spot yuan opened at 6.1967 per dollar and was changing hands at 6.2015 near midday, 47 pips stronger than the previous close and 0.92 per cent weaker than the midpoint.

The spot rate is currently allowed to trade with a range 2 per cent above or below the official fixing on any given day.

The yuan posted its strongest weekly performance since 2007 last week, gaining 0.85 per cent thanks to a rush of dollar sales over the past few days by major state-owned banks, possibly acting on behalf of the central bank.

However, market participants are still divided on how the yuan will perform over coming months as some believe the central bank's move last week was just to increase volatility and to curb sustained expectations of ongoing yuan depreciation.

The offshore yuan was trading 0.04 per cent weaker than the onshore spot at 6.204 per dollar.

Offshore one-year non-deliverable forwards contracts (NDFs), considered the best available proxy for forward-looking market expectations of the yuan's value, traded at 6.378, or 3.66 per cent weaker than the midpoint.

One-year NDFs are settled against the midpoint, not the spot rate, and now that the trading band has been widened to 2 per cent in either direction, corporates are much warier of using the NDF to hedge given the inherent basis risk inherent.

As a result the market has lost liquidity in recent years and has frequently proven itself to be an unreliable measure of market sentiment.