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Fed Signal Could Revive a Problem for China’s Central Bank
Any indication of readiness to lift rates more than the three times in 2017 could send the dollar higher, forcing the PBOC into action
By SAUMYA VAISHAMPAYAN
March 13, 2017 8:54 a.m. ET
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The Federal Reserve could revive a pesky problem for China’s central bank Wednesday, depending on the signal it delivers about the path of U.S. interest rates.
A recent round of speeches by Fed policy makers already has investors fairly confident of an increase short-term rates at this week’s policy meeting. Any indication that officials are ready to lift rates more than the three times they currently project for 2017 could send the dollar higher.
That includes against the yuan, especially in the offshore market where it trades more freely than it does domestically. The People’s Bank of China will again have to closely monitor trading in hubs like Hong Kong for bearish yuan bets to ensure that the onshore and offshore markets don’t diverge too much.
If enough negative yuan wagers accumulate, the PBOC might even decide to intervene in the offshore market, analysts say, as it has on several occasions in the past two years. A pullback in the dollar over the past two months has given the central bank some breathing room. The offshore yuan has gained 1.1% against the dollar this year, according to Thomson Reuters data.
Chinese officials “won’t want to see the renminbi drop too fast because of the U.S. dollar’s strength,” said Ken Cheung, Asian foreign-exchange strategist at Mizuho Bank in Hong Kong. That is especially the case this year, when stability is the key goal of China’s leaders. PBOC Governor Zhou Xiaochuan said last week the yuan’s exchange rate will stay largely steady in 2017.
Pricing in the forwards market indicates the offshore yuan will decline 3.2% in the next year, to 7.12 to the dollar, according to Thomson Reuters. Depreciation expectations have picked up recently, though they remain less frenzied than at the start of this year when the forwards market pointed to one dollar buying 7.33 yuan in a year’s time.
The evidence from the past two years suggests that the PBOC can very easily squeeze investors out of their bearish bets in Hong Kong, market participants say.
One option would be to direct state-owned banks to buy up yuan offshore, driving up the borrowing costs for the currency and so making it much more costly to short the yuan. The pool of yuan floating around Hong Kong is shrinking—yuan deposits tumbled nearly 40% in the year through January, according to the Hong Kong Monetary Authority—making it less costly for the central bank to push up borrowing costs in this way.
The central bank wants to prevent the offshore yuan from falling significantly more than the onshore yuan because a divergence tends to increase pressure on capital outflows. If Individuals and companies believe the yuan will depreciate, they are more likely to swap it for foreign currencies like the dollar—weakening the yuan further.
Chinese authorities have clamped down on many of the channels through which money can leave its borders, which has lessened the pressure for now. But most investors still expect a decline in the yuan against the dollar this year, pointing to the divergence of interest rates and economic growth between the two countries. Bank of America Merrill Lynch analysts recommend betting on dollar strength against the offshore yuan through the options market.
“President Trump will need a weak [dollar], but President Xi needs a weak [yuan],” the analysts wrote in a note. “We believe risk premium for a collision course is too low.”
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