China expected to defend yuan at key level as losses mount

Beijing

CHINA is likely to step in and defend the yuan should it fall to a key psychological level, as breaking through that point risks worsening sentiment in the country's beaten-down financial markets.

Most of the 18 traders and analysts surveyed by Bloomberg say policy makers will act to slow the currency's slide once it gets close to 6.7 per dollar in China's onshore market. That's about 1 per cent below current levels. The yuan reversed an early decline on Friday, climbing 0.2 per cent to 6.6132 per dollar as the euro led broad gains against the greenback.

The survey implies that yuan watchers think Chinese officials are comfortable with the currency's slump so far - even though its 11-day losing streak in Hong Kong through Thursday was the longest on record - but remain on watch for the panic that spurred heavy outflows in 2015.

The managed currency has slumped 3.5 per cent since June 14 - the worst performer in emerging markets - as concern over a slowdown in the world's second-largest economy collided with anxiety over the trade war with the US.

So far, the authorities refrained from heavy-handed intervention to stem the declines, a sign that some analysts say may suggest the policy makers are comfortable with the weakness and could allow even more.

A selloff in Chinese equities, which tumbled into a bear market this week, also soured sentiment toward the yuan, which until a few weeks ago served as an anchor for developing economies battling against the headwinds of rising global interest rates and the resurgent dollar.

China has already drawn on some of its arsenal to stem the drop, to little avail. The yuan is confined to a trading band 2 per cent either side of a reference rate set by the central bank each day, but so far stronger-than-expected fixings have been largely ignored by the market.

In order to prevent a break of 6.7, China could employ a number of tools, those surveyed said. Policy makers may continue to strengthen the reference rates, act to tighten liquidity levels between banks, or ramp up capital controls. A number of respondents also flagged the possibility of outright intervention declining this year.

"Until there's any noticeable improvement in sentiment - which could lead to capital inflows in the bond and equity markets - the yuan will remain under pressure," said Tommy Ong, managing director for treasury and markets at DBS Hong Kong.

But while Chinese intervention may trigger short-term rebounds in the currency, hesaid he expects it to continue Intervention was suspected on Wednesday, when the currency temporarily found a floor at 6.6 per dollar. At least one major Chinese bank was said to have sold dollars in the onshore market to keep the yuan stronger than 6.6. But while the currency did pare declines at the end of the Shanghai trading day, it extended losses on Thursday.

China has a history of acting to prevent the yuan breaching psychologically-important levels, amid concern that breaks hammer market confidence and can trigger a snowball effect. When the currency weakened beyond 6.7 per dollar in the Hong Kong market in September 2016, offshore yuan borrowing costs spiked, which some traders put down to Chinese intervention.

The yuan's losses have fuelled a wave of selling in emerging markets, with currencies from India to South Africa sliding as sentiment deteriorates. Developing-nation assets are set to cap their worst quarter since 2015, with the outlook for continued friction over trade between China and the US. A leaked report from a top Chinese think-tank warned of the potential for "financial panic" in the country amid the market selloff.

On Friday, the overseas exchange rate climbed 0.2 per cent after touching a seven-month low. Bloomberg's replica of China's CFETS RMB Index, which tracks the yuan against 24 currencies, is down 2.5 per cent from this year's peak, to 95.66.

Analysts are divided on the yuan's longer-term outlook: Nord LB economist Stefan Grosse, for example, expects the currency to sink to 7 per dollar in the next three months, while Nordea Bank AB's chief analyst Amy Zhuang sees the yuan rebounding, rising to 6.5 by the end of 2018.

Massive fund outflows, however, are not likely because of China's strict capital controls, said DBS' Mr Ong. BLOOMBERG