Yuan Surges in Hong Kong as Traders See PBOC Squeezing Bears

(Bloomberg) -- The offshore yuan jumped the most in four months as funding costs surged amid speculation policy makers were supporting the currency in the wake of a surprise sovereign rating downgrade.

The exchange rate rose as much as 0.8 percent to 6.7677 per dollar, its highest level since Nov. 4, before trading at 6.7731 at 5:37 p.m. in Hong Kong. The currency has rallied 1.6 percent, the most in Asia, since Moody's Investors Service cut its rating on China's debt a week ago. A short squeeze is hurting yuan bears, while the central bank has confounded analysts with stronger fixings.

The hand of the state has been speculated to be behind a rally in China's financial markets since Moody's said May 24 the nation's efforts to cut leverage would be insufficient to curb debt. On Friday, China said it's considering changes to the way it calculates the yuan's daily reference rate against the dollar, a move that's likely to reduce exchange-rate volatility while undermining efforts to increase the role of market forces in Asia's largest economy.

“The sharp gain in the offshore yuan is partially due to the unwinding of short yuan positions because the high offshore yuan funding cost has made the currency too expensive to short,” said Stephen Innes, senior Asia-Pacific currency trader at Oanda Corp. in Singapore. “Bears with short yuan positions would need to cut their exposure."

The overnight yuan interbank rate in Hong Kong, known as Hibor, surged 15.7 percentage points on Wednesday to 21.08 percent, the highest since Jan. 6, while the offshore yuan's overnight deposit rate jumped to 60 percent.

The increase in yuan funding costs is an increasing signal that authorities are intervening, said Nathan Chow, a Hong Kong-based economist at DBS Group Holdings Ltd. Officials may be reacting to prevent a negative reaction from Moody's downgrade, he said.

The PBOC's policies have driven up offshore yuan funding costs before, with the overnight interbank loan rate in Hong Kong surging to 66.82 percent in January last year. It hit 23.68 percent in September, and soared again this January to 61.33 percent amid tightened capital controls on the mainland.

--With assistance from Emma Dai

To contact Bloomberg News staff for this story: Robin Ganguly in Hong Kong at rganguly1@bloomberg.net, Helen Sun in Shanghai at hsun30@bloomberg.net.

To contact the editors responsible for this story: Richard Frost at rfrost4@bloomberg.net, Robin Ganguly

With assistance from Robin Ganguly, Helen Sun