Offshore yuan rises as borrowing costs surge amid reduced supply

[BEIJING] The offshore yuan strengthened for a second day as a shortage in the overseas market and surging borrowing rates pushed up the cost of betting against the Chinese currency.

The yuan overnight interbank rate in Hong Kong jumped to a five-month high as lenders set aside cash to meet regulatory requirements and on speculation authorities are tightening funding conditions to curb declines in the currency.

China's central bank intends to avoid any quick slides that could trigger massive short yuan positions, according to Commerzbank AG.

The yuan traded in Hong Kong rose 0.12 per cent to 6.6887 a dollar as of 12:58 pm local time, according to data compiled by Bloomberg. The exchange rate advanced for a second day after a run of losses that pushed it to a six-month low and widened its discount to prices on the mainland.

The onshore yuan climbed 0.11 per cent to 6.6856 in Shanghai. A Bloomberg replica of the CFETS RMB Index, which tracks the Chinese currency against 13 exchange rates, rose 0.19 per cent, the most since May, to 94.47.

"There's some speculation of a liquidity squeeze in the short-end," said Tommy Xie, an economist at Oversea-Chinese Banking Corp in Singapore. "It feels like the People's Bank of China is quite serious about defending the 6.7 level. This reminds me of what happened in January."

The overnight cost of borrowing yuan in Hong Kong surged to an improbable 66.8 per cent in January as the PBOC mopped up supplies of the currency in an effort to punish speculators who try and profit from the difference in the yuan's rates at home and abroad.

The one-day interbank rate surged 2.46 per centage points on Wednesday to 4.83 per cent, the highest since Feb 22, according to a fixing from the Hong Kong Treasury Markets Association.

The rates are surging this time round also because lenders have to comply with a reserve-requirement rule on yuan deposits held on the mainland at offshore participant banks, said Frances Cheung, head of Asia ex-Japan rates strategy at Societe Generale SA in Hong Kong.

Offshore banks had previously faced a zero per cent required reserve ratio on their yuan deposits on the mainland. As of Jan 25, those funds were subject to the same ratio as Chinese banks.

The offshore yuan's overnight forwards points more than doubled during early trading on Wednesday, according to data compiled by Bloomberg. This meant it became more expensive for traders to short the Chinese currency against the greenback, and prompted the market to cut back on long-dollar positions, said Ken Cheung, an Asian currency strategist at Mizuho Bank Ltd in Hong Kong.

"We have started to see some sort of liquidity tightening in the offshore market, which reminds the market of the PBOC's intervention at the beginning of the year," said Zhou Hao, an economist at Commerzbank in Singapore.

BLOOMBERG