SHANGHAI, Oct 29 (Reuters) - China's yuan firmed on Thursday, walking back losses that had been driven by a tweak to the currency's daily midpoint fixing methodology as the currency reverted to what is widely viewed as a long-term strengthening trend. But traders and analysts said the market remained cautious given significant uncertainty over U.S. elections and a surge in new global COVID-19 cases. The People's Bank of China set the midpoint rate at 6.726 per dollar prior to market open, weaker than Wednesday's fix of 6.7195. Spot yuan opened at 6.7220 per dollar and strengthened to 6.7111 at midday, 179 pips stronger than the late session close Wednesday. Its offshore counterpart strengthened to 6.7085 per dollar. The dollar took a pause on Thursday after rising on fears that fresh lockdowns in Europe could hit a fragile economic recovery. "The main risk is still the election. And the new lockdown in Europe is also weighing on sentiment - you saw the dollar go up," said a trader at a Chinese bank. "Regarding the election, some market participants have already priced in a Biden victory and believe if Trump is elected, that will be a black swan incident. It's getting more complicated," he said. Reflecting the rising uncertainty around the Nov. 3 election, one-week offshore Chinese yuan volatility traded as high as 12.038 on Thursday, its highest since August 2015. "It's just less clear as to how the markets are going to react. (The yuan) could have massive spikes in both directions," said Stephen Innes, chief global market strategist at Axi. The yuan has strengthened nearly 7% from late-May lows, lifted by China's firming economic recovery and steady inflows. In a move interpreted as reflecting Beijing's desire for more two-way volatility in the yuan's exchange rate, Chinese banks have suspended the use of a counter-cyclical "X" factor in the yuan's daily fixing formula. Some analysts say they see room for the yuan to continue its march higher. Many investors buying Chinese bonds had adopted a carry trade strategy with little hedging, boosting the impact of yuan buying, said Ji Tianhe, head of FXLM strategy for global markets China at BNP Paribas in Beijing. "Additionally, given Chinese exports remain strong, appreciation in the yuan is more likely to happen due to their sales of USD," he said. Ji said he sees the yuan strengthening to 6.5 per dollar by the first quarter of 2021. The yuan market at 4:04AM GMT: ONSHORE SPOT: Item Current Previous Change PBOC midpoint 6.726 6.7195 -0.10% Spot yuan 6.7111 6.729 0.27% Divergence from -0.22% midpoint* Spot change YTD 3.76% Spot change since 2005 23.33% revaluation Key indexes: Item Current Previous Change Thomson 94.77 94.58 0.2 Reuters/HKEX CNH index Dollar index 93.383 93.432 -0.1 *Divergence of the dollar/yuan exchange rate. Negative number indicates that spot yuan is trading stronger than the midpoint. The People's Bank of China (PBOC) allows the exchange rate to rise or fall 2% from official midpoint rate it sets each morning. OFFSHORE CNH MARKET Instrument Current Difference from onshore Offshore spot yuan 6.7108 0.00% * Offshore 6.8793 -2.23% non-deliverable forwards ** *Premium for offshore spot over onshore **Figure reflects difference from PBOC's official midpoint, since non-deliverable forwards are settled against the midpoint. . (Reporting by Andrew Galbraith and Winni Zhou; Editing by Stephen Coates)
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