Here Are the Theories Why China May Be Supercharging the Yuan

(Bloomberg) -- China's yuan has emerged from hibernation with an improbable surge that's left strategists asking -- why?

After meandering in a stable range against the dollar for most of the year, the yuan's break-out move -- which saw it jump to 2017 highs this week in both its on- and offshore markets -- came after officials said they were using a new method to set the fixing, a reference rate set each day that's used to manage the currency versus its U.S. counterpart.

While most agree the hand of the state is probably at play when it comes to the yuan's best-in-Asia move higher, what's less clear is the motivation. In January, officials were said to be intervening to burn speculators who'd built up bearish positions, but that doesn't seem to be the case this time.

Analysts have their theories - here's a round-up:

Moody's Shock

China was none too pleased with Moody's Investors Service's unexpected credit downgrade, which elicited a stinging rebuke from the finance ministry and a heap of criticism from state media. The yuan has jumped almost 2 percent offshore since the May 24 rating cut, which likely spurred intervention from the authorities and even the changes to the fixing formula, said Jason Daw, head of emerging-market currency strategy at Societe Generale SA.

Soothing Markets

Sentiment toward mainland Chinese assets had deteriorated before the Moody's move, with stock and bond markets whipsawing traders amid Beijing's deleveraging drive. Bloomberg Intelligence's Chief Asia Economist Tom Orlik says bolstering the yuan could be part of a broader effort to calm markets amid that crackdown. Also, with a twice-a-decade leadership re-shuffle in the Communist Party due later this year, China's tolerance for market volatility is low, he said -- the state is moving to “put a floor” under markets.
More from Orlik: Moody's Rating, Not Trump's Moods, Driving Yuan

Fed Factor

Orlik's other theory is that the People's Bank of China is bolstering the yuan pre-emptively, amid prospects of another interest-rate hike from the Federal Reserve this month. With evidence Chinese growth may have peaked for this year, the PBOC may not want to follow suit with its own tightening and is instead turning to other means to support the currency. Fiona Lim, senior currency analyst at Malayan Banking Bhd, subscribes to the Fed idea, saying policy makers may be wanting to build more guidance into the yuan to boost market confidence ahead of a prospective dollar rally. The PBOC didn't immediately respond to faxed questions about the yuan on Wednesday.

Price Mismatch

This one's for the FX nerds and has gained a lot of traction with currency strategists. Concern over the yuan being “consistently weaker” than the fixing rate at the end of the Chinese trading day triggered the changes to the reference rate, according to Gao Qi, a currency strategist at Scotiabank. What the PBOC viewed as irrational depreciation pressure on the yuan was preventing it from achieving a more “fundamentals-based” closing price, said Tim Condon of ING Groep NV. China tweaked the fixing formula -- which also incorporates the closing level -- to narrow the gap between this price and the reference rate. SocGen's Daw is also on board with this theory.

“It shows that China may prefer a stronger currency when the dollar weakens,” said Tommy Xie of Oversea-Chinese Banking Corp.

No More Weakness

Yuan weakness has been a hot topic since the election of Donald Trump, with the currency's three-year run of declines spurring claims that China is deliberately sending it lower to make its exports more competitive. While that pressure may have eased, the yuan's persistent weakness against currencies other than the dollar may be behind the recent bout of strength, said Khoon Goh, head of Asia research at Australia & New Zealand Banking Group Ltd.

“The authorities are not satisfied with the yuan merely remaining stable against the dollar,” they want losses versus a 24-currency basket to be arrested too, Goh said.

A “herd mentality” in markets meant there was a bias toward yuan weakness, said Peter Chia Chih Siong of United Overseas Bank Ltd.

Lingering Trump Concerns

While the U.S has backed off some of its more strident criticism of China's currency policy, Nomura Holdings Inc. analysts said in a May 26 note that they noticed a shift in the yuan's fixing regime from early April, just before Trump met with Chinese President Xi Jinping. The daily rate was coming in stronger than what the analysts who tracked it expected throughout April, fueling speculation of a tweak that was basically confirmed last Friday when the government said they were considering adding the “counter-cyclical adjustment factor” to the fixing formula. U.S. political pressure may be behind China's quest for a stable yuan, according to Nomura.

Belt and Road

China rolled out the blue skies for its Belt and Road summit last month, which saw leaders from around the world descend on Beijing as the government showcased what's shaping up to be its cornerstone diplomatic initiative. China has been pushing companies to use yuan as part of the global infrastructure spending spree, and the currency is up more than 1 percent onshore since the meeting. Improving the yuan's prospects and damping market volatility could boost overseas investor appetite for yuan-denominated assets, said Ken Cheung, an Asian currency strategist at Mizuho Bank Ltd. in Hong Kong.

--With assistance from Helen Sun Emma Dai and Will Davies

To contact Bloomberg News staff for this story: Emma O'Brien in Beijing at eobrien6@bloomberg.net.

To contact the editors responsible for this story: Christopher Anstey at canstey@bloomberg.net, Ravil Shirodkar, Sarah McDonald

With assistance from Emma O'Brien