China Is Expected to Defend Yuan If It Weakens About 1% Further

(Bloomberg) -- China's authorities, who've allowed the steepest yuan decline since the 2015 devaluation, are likely to step in and defend the currency should it fall further to a key level.

Most of the 18 traders and analysts surveyed by Bloomberg say policy makers will act to slow the currency's slide once it gets close to 6.7 per dollar in China's onshore market. That's about 1 percent below current levels. The yuan was little changed at 6.6266 a dollar in early London trading on Friday.

The focus on 6.7 implies that Chinese officials are seen as comfortable with the currency's slump so far, even though its 11-day losing streak in Hong Kong through Thursday was the longest on record. Still, a pattern of stronger-than-expected daily fixings suggests policy makers remain on watch for any signs of the panic that spurred heavy outflows in 2015.

The managed currency has slumped 3.4 percent since June 14 -- the worst performer in emerging markets -- as concern over a slowdown in the world's second-largest economy collided with anxiety over the trade war with the U.S. So far, the authorities refrained from heavy-handed intervention to stem the declines, a sign that some analysts say may suggest the policy makers are comfortable with the weakness and could allow even more.

A selloff in Chinese equities, which tumbled into a bear market this week, also soured sentiment toward the yuan, which until a few weeks ago served as an anchor for developing economies battling against the headwinds of rising global interest rates and the resurgent dollar.

Little Impact

China has already drawn on some of its arsenal to stem the drop, to little avail. The yuan is confined to a trading band 2 percent either side of a reference rate set by the central bank each day, but so far stronger-than-expected fixings have been largely ignored by the market.

In order to prevent a break of 6.7, China could employ a number of tools, those surveyed said. Policy makers may continue to strengthen the reference rates, act to tighten liquidity levels between banks, or ramp up capital controls. A number of respondents also flagged the possibility of outright intervention.

“Until there's any noticeable improvement in sentiment -- which could lead to capital inflows in the bond and equity markets -- the yuan will remain under pressure,” said Tommy Ong, managing director for treasury and markets at DBS Hong Kong Ltd. But while Chinese intervention may trigger short-term rebounds in the currency, Ong said he expects it to continue declining this year.

Intervention was suspected on Wednesday, when the currency temporarily found a floor at 6.6 per dollar. At least one major Chinese bank was said to have sold dollars in the onshore market to keep the yuan stronger than 6.6. But while the currency did pare declines at the end of the Shanghai trading day, it extended losses on Thursday.

China has a history of acting to prevent the yuan breaching psychologically-important levels, amid concern breaks hammer market confidence and can trigger a snowball effect. When the currency weakened beyond 6.7 per dollar in the Hong Kong market in September 2016, offshore yuan borrowing costs spiked, which some traders put down to Chinese intervention.

The yuan's losses have fueled a wave of selling in emerging markets, with currencies from India to South Africa sliding as sentiment deteriorates. Developing-nation assets are set to cap their worst quarter since 2015, with the outlook for continued friction over trade between China and the U.S.

A leaked report from a top Chinese think tank warned of the potential for “financial panic” in the country amid the market selloff, read more here.

On Friday, the overseas exchange rate climbed 0.1 percent after touching a seven-month low. Bloomberg's replica of China's CFETS RMB Index, which tracks the yuan against 24 currencies, is down 2.5 percent from this year's peak, to 95.66.

Here are some other key points from Bloomberg's survey:

• Respondents are divided on the longer-term outlook on the yuan: Nord LB economist Stefan Grosse, for example, expects the currency to sink to 7 per dollar in the next three months; while Nordea Bank AB's chief analyst Amy Zhuang sees the yuan rebounding, rising to 6.5 by the end of 2018.
• The main drivers for the yuan in the near term include what happens between the U.S. and China on trade, and how the greenback fares, according to those surveyed.
• The authorities may try to prevent the CFETS RMB Index from sliding beyond 95, according to Eddie Cheung, Asia foreign-exchange strategist at Standard Chartered Plc.
• Massive fund outflows, however, are not likely because of China's strict capital controls, according to DBS' Ong.
• The yuan's declines will be a setback for China's push to internationalize the currency, two traders who took part in the survey said.

To contact Bloomberg News staff for this story: Sarah McDonald in Singapore at smcdonald23@bloomberg.net

To contact the editors responsible for this story: Sarah McDonald at smcdonald23@bloomberg.net, Emma O'Brien

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