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China's yuan formula baffles analysts who can't predict the fix

Wednesday, January 13, 2016 - 10:47
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For a rate that China's central bank says is largely determined by easy-to-track market prices, the yuan's daily fixing is proving surprisingly hard for analysts to predict.

[TAIPEI] For a rate that China's central bank says is largely determined by easy-to-track market prices, the yuan's daily fixing is proving surprisingly hard for analysts to predict.

The reference rate, which restricts moves in the onshore yuan to a maximum 2 per cent on either side, has defied forecasts in recent days. Even after the central bank's research chief on Monday took the unusual step of clarifying how the rate is set, Royal Bank of Canada said Wednesday's fixing differed from what the monetary authority's methodology suggested it would be.

The disconnect is fueling speculation that Chinese authorities have reverted to their old approach of using the reference rate to guide moves in the yuan, backtracking on pledges to make the currency more market-driven. Uncertainty over the central bank's exchange-rate policy has sparked turmoil in global markets this year, erasing more than US$5 trillion from equity values and helping send commodity prices to a 16-year low.

"The real significance of the fixing is that the PBOC can use discretion to set it at a level that it wants, and it's not completely transparent," said Zhou Hao, an economist at Commerzbank AG in Singapore. "The central bank can use it to deliver a safety card, or a bomb, or whatever else that you don't expect." While Hao had predicted that the PBOC would keep its Jan. 8 reference rate near the previous session's official onshore closing price, the fixing was actually 0.5 per cent stronger.

The central bank has said the rate is determined by the yuan's last closing level, moves in a basket of global currencies that it unveiled last month, and considerations of market supply and demand. It's that last factor that gives the central bank wriggle room to shift the rate away from what market pricing would dictate, according to ABN Amro NV and RBC.

"They will continue to influence the next day's fixing depending on their subjective assessment of the market demand and supply, and in terms of whether the market direction is too one-sided," said Roy Teo, a Singapore-based senior foreign- exchange strategist at ABN Amro, which Bloomberg data show had the most-accurate forecasts for the yuan over the past year.

Sue Trinh, the Hong Kong-based head of Asia foreign-exchange strategy at RBC, estimates the fixing by adjusting the previous close with movements in other currencies and making a "judgment call" on demand and supply factors.

"That element of discretion is throwing off a lot of models at the moment," Ms Trinh said.

The People's Bank of China cut the reference rate by 1.1 per cent in the first four days of last week, spurring a worldwide plunge in stocks and the steepest weekly decline in the onshore yuan since a shock devaluation in August. The fixing was then held little changed for the next four trading days.

Policy makers have been clear in the past few days about signaling that they won't tolerate excessive weakness in the yuan. Bets against the currency will fail and calls for a large depreciation are "ridiculous" as policy makers are determined to ensure stability, Han Jun, the deputy director of China's office of the central leading group for financial and economic affairs, said Monday in New York. Downward pressure on the yuan is expected to ease, Ma Jun, the chief economist at the PBOC's research bureau, said in comments posted Monday on the central bank's website.

While policy makers appeared to use intervention in the foreign-exchange markets, rather than the fixing, to support the yuan after the August devaluation, that strategy led to an erosion of the nation's foreign-exchange reserves. The currency hoard shrank by a record US$513 billion last year to US$3.33 trillion, according to the central bank.

As authorities seek to avoid a sustained reduction in reserves, they're likely to revert to using the fixing to help manage swings in the currency, said Commerzbank's Mr Zhou.

"It's less expensive to intervene in the currency market with the fixing than by selling foreign-exchange reserves," Mr Zhou said. "It's a very important administrative tool that the PBOC will not give up in the foreseeable future."

BLOOMBERG