In the month since China changed how it calculates the yuan’s guidance rate, market participants have discovered that this factor is lopsided and operates mainly to thwart yuan depreciation. The undisclosed factor put in place by the People’s Bank of China (PBOC) to reduce price swings has been at play only on days when the yuan’s previous session close was weaker than intended. The central bank introduced the “counter-cyclical factor” into its formula that determines the mid-point reference rate for the yuan in late May saying it would allow the currency’s value to better reflect supply and demand.
That secretive factor has made it almost impossible for the market to estimate each day’s mid-point, around which the yuan is allowed to trade. Investors suspect the new formula is aimed at keeping the yuan stable, in particular to prevent it weakening excessively and to change market expectations around its depreciation. Mid-point fixings in June appear to support their theory.
“The counter-cyclical factor was triggered to support the midpoint, when the previous day’s close was weaker than the fixing, suggesting that the depreciation pressure was building up in the market,” said Ken Cheung, Asian FX strategist at Mizuho Bank in Hong Kong.
Market watchers who have built models to mimic the PBOC’s formula suspect the factor was not included in daily midpoint fixings between Wednesday and Friday last week, when the dollar was weak across currencies and the yuan ended the local session each day stronger than the fixing the previous day.
“The introduction of the counter-cyclical factor has allowed the central bank to regain its price right on the midpoint,” said Cheung, noting the authorities now have more power to use the midpoint to guide the same day’s yuan movement.
Analysts say yuan policy is less transparent but the change was probably implemented to remove deeply entrenched expectations the currency is a one-way bet down. The renminbi fell 6.5 percent against the dollar last year and domestic outflows remain heavy despite capital controls.
The “counter-cyclical factor” worked well to alter bearish perceptions of the yuan in the first two weeks after the change as the currency was kept largely stable. A slew of investors who had bet on losses in the yuan liquidated their short positions. “The adoption of the counter-cyclical factor has strengthened the idea that the yuan would start to strengthen,” said a senior trader at a Chinese bank in Shanghai.
The yuan fixing strengthened 1 percent against the dollar between May 31 and June 9, helping nudge the currency up 0.8 percent even though the dollar was largely flat in the same period. June has traditionally been a period of high corporate dollar demand in China, and rising dollar purchases subsequently forced the yuan to give back more than half of the gains it made in late May and early June. The yuan’s local close was persistently weaker than its fixing between June 15 and June 26.
The old model for the fixing was based on the yuan’s local close, along with moves of the U.S. dollar against currencies of China’s main trading partners. That meant that during periods of yuan weakness, the PBOC was forced to fix a weaker guidance the following day, traders said.
The “counter-cyclical factor” has changed that. On average, every 1 pip intraday weakening in the onshore yuan spot rate would lead to about a 0.7 pip strengthening in the fixing relative to what is implied by CFETS model, Goldman Sachs said in a note this week.
“While the counter-cyclical factor can be used to transmit policy guidance, for credibility it may need to be coupled with occasional meaningful yuan moves driven by actual FX intervention,” economists at Goldman Sachs said. That too has been taking place. Multiple traders told Reuters last week that they saw Chinese state-owned banks selling dollars in the market, in an apparent attempt to keep the yuan from declining.