Yuan's Surge Offshore Is Driven by Soaring Onshore Shorting Cost, Dollar Consolidation
Yicai Global
/SOURCE : Yicai
Yuan's Surge Offshore Is Driven by Soaring Onshore Shorting Cost, Dollar Consolidation

(Yicai Global) Jan. 5 -- Tight offshore yuan funds, the soaring cost of shorting the yuan onshore and dollar consolidation have been the major factors behind the continuous strident gains in the yuan offshore (CNH) rate so far this year, according to experts.

At the end of last year, there was widespread concern about the yuan's trajectory in 2017. At the start of the year, however, the offshore yuan experienced unusual stability and saw big increases yesterday and today.

The CNH rose more than 400 points to breech the 6.92 threshold yesterday, then stayed above 6.87. Today it climbed to 6.8216 at 1.30 p.m. local time in China, allaying previous concerns about 'breaking 7.' The onshore yuan-dollar exchange rate closed at 6.9247, rising significantly from 6.96 where it hovered for a long time.

"Without much solid ground, the CNH exchange rate is easy to rise but difficult to fall," said Xie Yaxuan, chief macroeconomic analyst at China Merchants Securities Co. "In addition, CNH short positions set before 2017 might aim at fighting against the increased pressure from currency exchange at the start of 2016. But due to a series of management measures by the State Administration of Foreign Exchange, foreign exchange purchases were rather stable at the beginning of the year and short covering was also one reason for the strong exchange rate."

"I didn't see obvious signs of intervention behind the CNH's sudden surge from the afternoon to evening of Jan. 4, though many people speculate that China's central bank intervened in the offshore market," said Zhou Hao at Commerzbank AG. "To a large extent, the soaring CNH reflects the delicate relationship between 'costs' and 'expectations.'"

Zhou said there is a cost of shorting the onshore yuan (CNY) and the cost is reflected in the differences between the CNY's interest rate and the dollar in different periods. Generally speaking, if you borrow CNY to short, you need to pay the CNY interest rate but at the same time dollar interest will be charged. The difference between the two is the 'cost.' Under normal circumstances, the CNY interest level is higher than the dollar's, so shorting the CNY is a "negative spread" transaction.

Zhou added that the so-called spot price is in fact made based on the 'T+2' model, meaning delivery is two trading days after the transaction. For the traders, this is a game. If the CNY cannot devalue more than 0.01 within two days -- for example, from 6.95 to 6.96 -- then shorting spot CNY is of little significance.

Another major reason for the CNY's gains is the dollar's pullback. Previous strong dollar gains were rooted in the US Federal Reserve's hawkish stance, implying that the dollar interest rate is expected to increase three times this year. But, from the Fed's December meeting minutes, released today, the central bank seemed not to be as hawkish as imagined.

"Fed policymakers supported step-by-step rate hikes and expressed uncertainty about the effects of fiscal policy," said Cui Rong, a senior foreign exchange trader. "Especially the policies that may be implemented after Donald Trump's coming into power on Jan. 20 make the market uneasy. Plus the coming announcement of the non-farm payroll report, it is reasonable for the market to make position adjustments to steer clear of suspicion."

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