One day after Turkey unleashed measures to crush Turkish Lira shorts, China did the same and on Thursday, the offshore Yuan tumbled by 0.7% from as low as 6.94 to 6.8825 – the biggest drop since July 25 – after the offshore Yuan’s 12 month forward points soared from 350 bps to 830bps, the biggest one-day move since January 2016 – sending the cost of short bets against the Yuan soaring, with the spike in CNH forward points making it riskier, and more expensive, to short the Yuan.
Separately, CNH tomorrow-next forward points soared as much as 15.7 to 15, before paring the increase to 3 in an attempt to force stops by Yuan shorts.
“Two reasons are supporting the yuan today: the restart of China-U.S. trade talks, and the widespread market rumor that some banks at Shanghai free-trade zone are not allowed to lend the yuan to offshore banks,” a move that could squeeze liquidity, said Scotiabank’s Gao Qi. “The yuan may stabilize at the current level or even strengthen in the near term, as sentiment improves on the trade front. Its fate in the longer-term hinges on the trade talks and Turkey.”
A Reuters report confirmed the move was driven by China limiting CNH liquidity to increase cost of shorting CNH, similar to what Erdogan did to Lira shorts earlier this week. Specifically, China banned banks in its free trade zones from certain lending activities to ease pressure on the yuan currency in offshore markets.
The restrictions, announced by the Shanghai branch of the PBOC on Thursday morning, closed off channels used to deposit and lend yuan offshore through the trade zones as the currency plumbs 15-month lows. They prevent commercial banks from using some interbank accounts to deposit or lend yuan offshore through free trade zone schemes. And while the restriction on offshore yuan deposits and lending applies to some Free Trade Accounting Unit (FTU) businesses, it is not meant to affect cross-border capital flows that reflect real demand, according to the notice.
The yuan surged on the news, adding to earlier gains that were fueled by a stronger-than-expected daily fixing from the central bank and a report that Chinese and U.S. officials will engage in low-level trade talks later this month.
“Many offshore investors unwound their short yuan positions today,” said Zhou Hao, senior emerging markets economist at Commerzbank AG in Singapore.
As Bloomberg notes, Chinese authorities have been trying to limit bets against the yuan after the currency depreciated more than 9% since March, approaching the closely watched level of 7 per dollar. While a weaker exchange rate has helped Chinese exporters weather the impact of U.S. President Donald Trump’s tariffs, policy makers worry that a disorderly drop could trigger capital outflows and threaten China’s financial stability; it could also lead to further anger among the Trump administration and accusations of devaluation, just as a Chinese trade delegation is set to come to Washington.
As the yuan’s slump has accelerated in recent weeks, the People’s Bank of China has taken several steps to slow its drop. Two weeks ago, the central bank made it costlier to place short bets against the currency with forwards. And last week, the monetary authority urged big banks to avoid bearish momentum trades.
To be sure, the PBOC’s response has been well rehearsed: during a similar selloff in the Yuan in 2015 and 2016, Chinese authorities squeezed yuan bears by lifting offshore funding costs dramatically. They also spent billions in foreign-exchange reserves to buy the currency and clamped down on capital outflows.
While the government’s response this time around has been much less extreme, policy makers have sent a clear message that they want to avoid disorderly swings in the exchange rate, according to Carie Li, an economist at OCBC Wing Hang Bank in Hong Kong.
“PBOC’s bottom line is to prevent one-way yuan depreciation,” Li said. “Investors probably have unwound short-yuan positions amid fear of further intervention.”
And if they haven’t, the PBOC will simply do the same thing again and again, until the “evil speculators” fold again, as they did back in 2015 and 2016.