China's yuan weakens; money rates rise as central bank drains liquidity

[SHANGHAI] China's yuan weakened against the US dollar on Tuesday as the greenback hovered near a four-week high against a basket of currencies, while interbank money rates edged up after the central bank drained funds for a second day.

The People's Bank of China set the midpoint rate at 6.8806 per US dollar prior to market open, firmer than the previous fix of 6.8898.

The spot market opened at 6.8788 per US dollar and was trading at 6.8804 at midday, 24 pips weaker than the previous late session close and flat from the midpoint.

The US dollar pulled back from recent highs against major currencies on Tuesday but traders expect it will resume its upward trend on the back of Federal Reserve rate hike expectations and US president Donald Trump's upcoming tax reform plan.

A gauge of measuring US dollar strength against six other currencies stood at 100.94 at midday, not far from Monday's high of 101.11, which was its highest since Jan 20.

"The market was balanced. But traders are becoming more cautious due to recent volatility in the US dollar and take a short-term trading strategy," said a trader at a Chinese bank in Shanghai.

The trader noted that many market participants now adopted a"buy low, sell high" approach to quickly lock in profits, rather than holding either long or short US dollar positions for longer periods of time as had often been the case.

Such a trading strategy has created some two-way volatility in the Chinese currency in recent trading sessions, with the currency fluctuating between 6.85 and 6.88 per US dollar.

The forex market took in stride data published by the government on Tuesday that showed producer price inflation and consumer inflation picking up more than expected in January.

The spread between onshore and offshore yuan widened slightly on Tuesday, after the two spot rates converged on Monday and the onshore spot rate briefly traded firmer than its offshore counterpart for the first time since early January.

The gap stood at 125 pips. The offshore yuan was trading 0.18 per cent firmer than the onshore at 6.8679 per US dollar.

In the money market, the volume-weighted average rate of the benchmark seven-day reverse repurchase agreement edged up to 2.5003 per cent on Tuesday morning, more than five basis points from the previous day's closing average rate. The rate is considered the best indicator of general liquidity in China. Overnight and 14-day repo rates were also up.

Primary money rates were rising after the central bank drained funds via open market operations for two straight days. The PBOC had skipped reverse repurchase agreement deals for six straight trading days before Monday.

The PBOC injected 130 billion yuan through reverse repos on Tuesday morning, while 230 billion yuan of such repos was set to mature. The central bank has drained a net 190 billion yuan so far this week, and an additional 480 billion yuan of reverse repos are due to come due this week.

The market was anxiously looking for clues as to whether the central bank would roll over other forms of liquidity support, and some banks were accordingly less willing to lend out funds.

Temporary liquidity facility (TLF) loans are due to mature on Friday. The TLF was introduced by the central bank in mid-January to help keep major commercial banks flush with funds.

Some market participants said the TLF had added around 600 billion yuan in liquidity.

One batch of central bank-issued Medium-Term Lending Facility (MLF) loans, with a total value of 151.5 billion yuan, was set to mature on Wednesday. Another batch of 53.5 billion yuan would expire on Sunday, according to Reuters calculations based on official data.

The Thomson Reuters/HKEX Global CNH index, which tracks the offshore yuan against a basket of currencies on a daily basis, stood at 95.22, firmer than the previous day's 95.06.

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 7.112, 3.25 per cent weaker than the midpoint.

One-year NDFs are settled against the midpoint, not the spot rate.

REUTERS