Firms' Forex Fervor Fells Yuan, but Dollar Lacks Luster in Second Half, Traders Say
Zhou Ailin
DATE:  Jul 04 2018
/ SOURCE:  Yicai
Firms' Forex Fervor Fells Yuan, but Dollar Lacks Luster in Second Half, Traders Say Firms' Forex Fervor Fells Yuan, but Dollar Lacks Luster in Second Half, Traders Say

(Yicai Global) July 4 -- Companies' hastened purchases of foreign currencies is a key cause of the recent quicker yuan drop against the dollar since the start of June, foreign-exchange traders and investors from a range of Chinese-funded and foreign-invested banks said in interviews with Yicai Global. They are less sanguine on the dollar's trend in the second half, however.

The yuan slid against the dollar at a speedier pace last month, falling nearly 7 percent from its peak of 6.241 per greenback tallied in March to 6.7167 yesterday.

A delay in the settlement by foreign-exchange settlement firms and accelerated purchases by foreign-exchange buying enterprises pushed the yuan down more quickly, with the view prevailing that China's central bank is highly tolerant of its depreciation, especially considering the lack of a significant rise in the US dollar index since last month, traders told Yicai Global.

The offshore yuan started to rally from the initial low point to a threshold of 6.67 per dollar yesterday, up nearly 400 points on the intra-day low point, while the onshore redback also strengthened to end its earlier drop of over 500 points following a pep talk from Yi Gang, the central bank's governor and another afterward by Pan Gongsheng, its deputy.

These traders seemed less than upbeat over the buck's trend in the year's remaining six months, however, saying current dollar holdings have shifted to a state that leaves little room for further upward mobility.

Careful observation of market trends would find without difficulty that this round of yuan depreciation started in April and sped up in June, with a single-month fall nudging 4 percent in June. This came after the market overvalued the yuan against a basket of currencies.

The slight weakening of the yuan against the dollar stood in contrast with a more than 10 percent depreciation seen in other emerging markets around April, a trader from a major state-owned bank told Yicai Global, "At that time, companies continued to show a keen appetite for foreign-exchange settlement, which in part propped up the yuan."

Sell Calls

"Some foreign-exchange settlement firms believing in the limited weakness of the yuan were then willing to sell part of their call options and collect some option premium. Even if the price slid to the strike price, they were still willing to exercise their options as most were originally planning on foreign-exchange settlement," an assistant general manager and trading director of the financial market department of a foreign-invested bank in China told Yicai Global.

The market did not, however, foresee that subsequent yuan depreciation would be faster than expected. The currency continuously lost value in May and June after the dollar index swelled nearly 4 percent in April.

This eroded the previous market belief in a stable redback. "The yuan's central parity rate against dollar posted daily by the central bank has steadily weakened recently, thus fostering the view that the central bank has a relatively high tolerance of a weak yuan. Therefore, companies are hastening their purchase of foreign currency, further upping market demand for dollars," the trader told Yicai Global. 

"Companies which need to carry out foreign-exchange settlement have been shy of selling off dollars and their willingness to go in for in foreign-exchange settlement may wane as the yuan keeps dropping," he added.

The continuously hemorrhaging outflow of capital and funds from emerging markets they were originally optimistic about -- even the Asia-Pacific markets with their sound fundamentals -- is also an impetus for the generally weak Asian currencies in recent days, including the yuan.

"Large funds were starry-eyed about emerging markets at the beginning of the year as they were positive about the global growth which emerging markets boost. However, political risks kept popping up in the eurozone that bolstered the dollar and sharply undercut emerging currencies until some speculative funds and even mid- and long-term funds started to pull out, thus generally enfeebling Asian currencies," Fu Yunjie, a portfolio analyst and trader focused on Asian bonds, told Yicai Global.

Asian currencies also generally come under seasonal pressure from April to July, Fu noted. "Transnational companies distribute their dividends during this time, and this also affects exchange rates," he added.

Stalling Dollar

Most institutions'  forecasts at the start of the year seemed to anticipate the dollar weakening through the year, while the renminbi would remain robust and emerging market assets would maintain their momentum. Many institutions hold the current situation is still very likely to reverse in the second half.

"The offshore rate of the yuan against the dollar has risen steeply to the threshold of 6.7, and the RSI [relative strength index] on the weekly chart has peaked, which does not rule out the possibility that the dollar rally will end there," said Stephanie Aymes, chief forex technical analyst at Societe Generale.

Extreme current pessimism about the euro and emerging market currencies is also liable to execute an about face. "The dollar's ascent is not because the US economy is too strong or emerging markets too weak, but because political risks in the eurozone have defied expectations, leading to a steady influx of safe-haven funds into the US and thus pushing the yield on 10-year US treasuries down to about 2.9 percent," said Fu. When market feeling is pessimistic, this easily reverses, he added.

For example, EU leaders agreed on a package of measures to limit migration flows and refugee counts at an EU eurozone reform-themed summit from June 28 to 29. This dispelled fears of a major rift in EU unity, entrenched the power of German Chancellor Angela Merkel's party and undoubtedly gave a fillip to the euro. The news also immediately sparked a short rally, in which the currency rebounded over 130 points from its daily low against the buck, nearing the 1.1700 threshold again.

Investors' dollar positions have now risen above the middle, so the scope for further increases is limited. The withdrawal from emerging markets has been led by mid- and long-term investors. At the end of the day, those remaining are longer-term investors, limiting future declines in emerging market currencies, and so a rebound may be just around the corner in the third quarter," Fu said.

Capital-account inflows have been an important factor underpinning the yuan's performance this year. Foreign institutions bolstered their holdings of yuan bonds by CNY60.50 billion (USD9.12 billion)  in May, a record high driven mainly by the dual attractiveness of interest and exchange rates, but the recent dollar rally will have little impact on the allocation of these assets, Yicai Global has learned.

The forecast that the Fed will raise interest rates twice this year has been included in market projections, and this may loosen the squeeze on emerging currencies.

Institutions Yicai Global interviewed generally expect the yuan to fluctuate between 6.25 and 6.75 in the second half if the dollar index roots in the 90-100 range. The chances of the renminbi falling below seven against the greenback this year thus appear low. 

Editor: Ben Armour

Follow Yicai Global on
Keywords:   Currency Market,RMB,US Dollar,Market Trend Analysis