China’s yuan crashed against the dollar on Jan. 30 in offshore trading, spurring rumors that a central bank action to devalue the currency could be imminent.
Offshore yuan’s valuation dropped to 6.28 per U.S. dollar in New York Friday afternoon, which is a two-year low. The rate is also 2 percent lower than the official midday fixing by the People’s Bank of China (PBOC), China’s central bank.
There are two exchange rates for the Chinese yuan. One is the official reference exchange rate (USD-CNY) set by the PBOC daily in China. This rate trades in a narrow band as designated by the central bank. The other exchange rate (USD-CNH) is for overseas trading of the yuan. This rate is watched by the international community as trading is open to foreigners and many FX traders deem this to be a more accurate rate which is less manipulated by the PBOC.
When there’s a spread between the official and offshore rate, it usually signals a dislocation in demand for the currency between mainland and offshore traders. It could also means that traders are predicting a policy action in the near future.
Currency Devaluation
The U.S. dollar’s recent surge prompted central banks of many export-oriented countries to cut rates and weaken their currencies.
Last week, the central banks of Russia and Denmark both trimmed official interest rates. The action followed similar decisions earlier at the European Central Bank, and the central banks of Japan and Korea to devalue their currencies.
Lowering interest rates could stimulate lending and investments, while a weak currency could spur demand for that country’s goods and products.
That puts the PBOC in a tough spot. So far, the PBOC has tried to rein in such lending to curb bad debts and slow down certain overheating asset classes. But the country’s export-driven economic engine has stalled in recent months, and given the recent export-friendly moves by its competitors Japan and Korea, the PBOC may have no choice but to take action.
Dollars in Demand
The yuan has already been pressured by asset conversion undertaken by wealthy Chinese. Locals recently rushed to convert their yuan-denominated assets into dollar-denominated investments.
The disposition of yuan-denominated assets has been a concern for the Chinese Communist regime. So much so that the government has urged caution for anyone considering to sell their yuan assets. On the Chinese-language China Business News, a report noted that U.S. dollar-denominated notes generated 1.2 to 2.5 percent in annual returns, while yuan-denominated products had returns of 3 to 5 percent.
But most astute investors in China probably already know that the stability and appreciation potential of dollar-denominated assets would likely trump most high-yielding yuan-denominated financial products, risk-adjusted.
