Yuan Losses Sow Doubts on its Resilience as Economic Toll Mounts
2022.04.22 08:35
Yuan Losses Sow Doubts on its Resilience as Economic Toll Mounts
(Bloomberg) — The yuan’s biggest weekly loss since 2019 is spurring investor concern on whether it’s reaching an inflection point after two straight years of gains.
Options traders are pricing in a further weakness for the onshore yuan after it breached a key technical support level on Wednesday for the first time since September. The cost to hedge declines in the offshore yuan surged to the highest in almost 18 months. A gauge of implied volatility — expected swings based on options prices — for the currency also jumped to the highest in more than a year.
The moves were triggered by the relentless surge in U.S. yields as they threaten to exacerbate outflows from China’s bond market. The People’s Bank of China’s move on Wednesday to set a weaker-than-expected currency fixing also dissuaded yuan bulls, while President Xi Jinping defending the lockdown-dependent approach to fighting the pandemic added to economic growth concerns.
“It does seem that options markets have been surprised,” said Alvin Tan, head of Asia FX strategy at Royal Bank of Canada Plc. “Risk reversals racing higher is a confirmation of the changed market sentiment on dollar-offshore yuan,” Tan said, adding that he doesn’t rule out the offshore yuan falling below 6.60 per dollar by the end of the year if economic risks grow.
The onshore yuan fell 0.3% 6.4723 per dollar set for its biggest weekly decline since Aug. 2019 on a closing basis.
Here are the charts illustrating the changing sentiment on the yuan:
Surging Activity
Dollar-yuan was the most traded currency pair in the options market for a second day on Thursday taking the week’s total transaction volume to $49 billion, Bloomberg data show. An upward breach through the 6.40 per dollar level and breach of its 200-day moving average support confirms the termination of months of consolidation for the currency, China International Capital Corp. said in a report Thursday. This could prompt a new wave of speculation on yuan entering a new trading range, it said.
“The PBOC has been signaling to corporates to be risk neutral on FX exposures, which should imply a reduction of their dollar longs,” said Arindam Sandilya, head of emerging Asia local markets strategy and FX derivatives strategy at JPMorgan Chase & Co. (NYSE:JPM) in Singapore. “This is a bulwark against dollar-onshore yuan depreciation.” Sandilya estimates banks and corporates accumulated about $640 billion of dollars over the last two years.
Turbulent Markets
Implied volatility for dollar-offshore yuan shot higher across all tenors after the currency pair broke out of the range it had been in since Oct. 20. One-month dollar-offshore yuan volatility surged to the highest since February 2021 before stabilizing Thursday.
A local news report citing a former PBOC offical’s forecast for a weaker yuan also added to doubts on its trade surplus-induced resilience.
The central bank is less concerned about defending a “magic level”, according to Zhennan Li, chief China economist at AllianceBernstein (NYSE:AB). It wants to avoid accumulation of speculative or “herding factors” in the market, he said, adding that “If depreciation expectation keep persistently accumulating, and the pace of depreciation becomes too fast, the PBOC may come out to guide expectation.”
Easier Shorts
The PBOC set the reference rate for the yuan 49 pips stronger than expected on Friday. That’s after it set the fix 101 pips weaker than forecast on Wednesday.
Some traders had seen Wednesday’s fix as a sign of the central bank’s discomfort with the currency’s strength against the backdrop of a slowing economy.
The offshore yuan forwards curve flattened in response to the PBOC’s move, allowing for cheaper entry into yuan shorts. The one-year points are close to the lowest in two years as expectations of further policy easing persist even as the loan prime rates were kept steady on Wednesday.
Speculators began to take advantage of relatively loose offshore yuan liquidity to build up short positions after the currency weakened past 6.40 per dollar, an offshore trader said. Dollar demand from corporate clients hedging against yuan depreciation risks in the forwards market has increased, said the trader, who asked not to be identified as they aren’t authorized to speak publicly.
Dollar Bets
Traders are unwinding structural bets on yuan strength and positioning for a stronger dollar. The one-month risk reversal, a measure of hedging cost, jumped to 1.34% on Wednesday — a level last seen in November 2020. The risk reversal skew has shifted toward a stronger dollar as traders price aggressive rate hikes by the Federal Reserve.
(Updates throughout.)
©2022 Bloomberg L.P.
