One week ago, with the Yuan having traded within fractions of what many consider a key psychological level for the USDCNY at 6.70, we reported that as many traders expected that following the just concluded G-20 meeting in China, the PBOC would finally relent in its devaluation defense, and let the currency slide on through to the other side. Not only did that not happen, but last Thursday the Chinese Central bank unleashed an unexpected and aggressive attack on currency Yuan shorts, the biggest since the January devaluation scare when the cost of borrowing yuan in Hong Kong soared to a seven-month high amid. The overnight HIBOR, or Hong Kong Interbank Offered Rate, jumped – seemingly without reason – by 3.88% points to 5.45%, the most expensive since February, according to Treasury Markets Association data. Other tenors joined with the one-week rate rose 2.09% points to 4.06%.
Then overnight, the onshore Yuan gained even more following the latest CNY fixing at 6.6895 (some had expected that based on the USD move, the PBOC would have to finally fix the currency above the key 6.70 level) with USD/CNH seeing broad-based selling driven by banks turning to spot market to reduce CNH funding needs. The reason for that is that after last week’s dramatic spike in overnight funding rates, this morning Hong Kong’s overnight interbank yuan borrowing rate, or the yuan hibor, shot up to its highest level since February , soaring nearly threefold to 8.16% from only 2.84% on Tuesday.
Even more acute, the 1-week yuan hibor was set at 10.15% according to the Treasury Markets Association.
One reason for the latest surge in funding costs is that with Chinese and Hong Kong holidays on deck, liquidity is scarce. The Hong Kong market will be closed on Friday for the mid-autumn festival and the China markets will be closed on Thursday and Friday. China has traditionally intervened in currency markets just before holidays: according to the FT, last October using illiquidity just before its long National Day celebrations to intervene in Hong Kong and reduce an embarrassingly wide gap between the offshore and onshore rates.
Of course, next week we will have the Fed and BOJ meetings as well, where uncertainty is leading to even more illiquidty.
However, the most likely explanation is that in order to force Yuan shorts to capitulate as 6.70 remains just barely within reach, the PBOC is simply continuing to squeeze the yuan shorts and raising the cost of shorting yuan, as explained last week. Ultimately, the PBoC weakened its yuan fix by 169 pips to 6.6895 versus yesterday’s 6.6726, even as many were expecting the USDCNY to finally breach the the 6.70 resistance level, the defense of whjich may have explained today’s aggressive spike in HIBOR tightening.
Interventions to dampen volatility are not costless, warned Hao Zhou, strategist at Commerzbank. “On one hand, the market volatility will surge, which could lead to sell off in risk assets, therefore cracking down the market confidence,” he said. “On the other hand, as the central bank frequently intervenes, the market will tend to believe that CNY depreciation is inevitable, resulting in further capital outflows.”
And so the PBOC, like the Fed, remains trapped.
Confirming that today’s action was merely another intervention, Bloomberg reports that big Chinese banks sold dollars to support the currency: at least three Chinese banks sold USD onshore, pushing CNY higher, two traders were quoted by BBG. USD/CNH selling was also seen, focused on covering funding needs, according to FX traders in North Asia