SHANGHAI: As macroeconomic risks induce unprecedented levels of volatility in the Chinese yuan, investors are betting authorities could widen the currency’s tight trading band for the first time since 2014 to allow market forces to have more say.
The Chinese yuan is allowed to move within a tight 2% range against the US dollar, around an official daily midpoint set by the People’s Bank of China (PBOC).
In the 8 years since the band was set, the currency has rarely moved more than 1% either side of the midpoint.
It lost its languor in September as an aggressive Federal Reserve and robust dollar pushed the yuan to the 7 weaker side against the greenback, foreign capital fled a struggling economy amid regulatory crackdowns and of COVID-19, and the PBOC seemed fine with letting market forces decide where the yuan should be.
“We see the possibility of the PBOC widening the yuan’s daily trading range against the dollar to 3% from 2% in 2023 given greater tolerance for increased market volatility,” said Becky Liu, head of strategy. Chinese macro at Standard Chartered Bank. .
The daily volatility of the yuan reached 16% on some days in October, compared with a range of 1% to 4% in previous months and years. The currency came close to touching the weak end of the band in five of the 16 trading days in October.
Implied volatility, an options market indicator of future volatility, has increased. An options trader said the market was “long volatile.”
One-, three- and 6-month yuan implied volatility hit record highs, while 9-month and one-year maturities are at their highest levels since Beijing’s currency reforms in 2015, when it projected a sharp 2 percent devaluation .
The PBOC doubled the daily trading range for the currency to 2% in 2014, in what some market participants called a bid to get the yuan into the IMF’s basket of currencies. It was included in 2016.
Political sources told Reuters that they have been considering widening the trading band in recent years to demonstrate their commitment to long-term market reforms.
“If the PBOC wants to widen the trading band, it will likely happen in the latter part of 2023, when the economy visibly rebounds and interest rate differentials with the US could also start to narrow significantly to favor the renminbi” said Tommy Wu, senior China economist at Commerzbank.
The PBOC did not respond to Reuters’ request for comment on market expectations.
In its latest quarterly report on monetary policy implementation, the PBOC promised to “allow markets to play a decisive role in determining the exchange rate.”
The Chinese yuan is down about 11% against the dollar so far this year and looks set for the biggest annual drop since 1994, but global investment houses expect it to recover gradually in 2023.
Increased volatility in yuan-ruble trading earlier this year prompted the central bank to double the pair’s trading range to 10% in March.
However, most analysts who think bandwidth expansion is due don’t even think it is imminent.
“Band-widening is unlikely to occur until it becomes clear that the US dollar’s cyclical uptrend has peaked, because any such action could be interpreted by the market as a signal of further renminbi depreciation said Alvin Tan, head of Asia FX at RBC Capital Markets, referring to the yuan by its alternative name.
“The PBOC probably needs to see that the Fed’s rate-hiking cycle is definitely over.”
