August 27, 2018 / 2:03 AM / in 2 months

Yuan hits four-week high as China signals support, revives X-factor for fixing

SHANGHAI (Reuters) - China’s yuan finished Monday afternoon trade at a near 4-week high to the dollar after the central bank revived a “counter-cyclical factor” in its daily fixing to support the currency, halting a record 10-week slide that rattled global markets and irritated Washington.

FILE PHOTO: A China yuan note is seen in this illustration photo May 31, 2017. REUTERS/Thomas White/Illustration/File Photo

The announcement was seen as the latest signal from the People’s Bank of China (PBOC) that is not comfortable with further depreciation in the yuan which could spark capital outflows from the cooling economy.

The move late on Friday came a day after the latest Sino-U.S. talks aimed at resolving the trade dispute ended with little progress, with tougher U.S. measures expected to kick in next month that could add more pressure on the Chinese currency.

President Donald Trump, in an interview with Reuters last week, had accused China of manipulating its currency to help cushion the blow from U.S. tariffs on Chinese imports.

Monday's domestic closing price was the strongest since Aug. 1. Spot yuan CNY=CFXS opened onshore trade at 6.8080 per dollar and closed domestic trade, at 0830 GMT, at 6.8171, or 19 pips firmer than the previous late night session close.

“Given China has drawn the line in the sand clearly, the outlook of the yuan may depend on China’s economic fundamentals other than the dollar trajectory,” Tommy Xie, economist at OCBC in Singapore, said in a note.

“Should China’s economy decelerate more than expected, the pressure on RMB weakness may come back again. Otherwise, we expect the USD/CNY to stay below 7 comfortably,” he said.

The PBOC said it was adjusting how the yuan’s official midpoint was calculated to keep the currency more stable amid dollar strength and trade tensions, but gave no details as to how the new “X” factor is derived.

With little sign of compromise in the trade talks, most market watchers had predicted it was only a matter of time before the yuan tested the closely watched and psychologically important support level of 7 to the dollar.

The PBOC’s move “validates our views that yuan devaluation is not a weapon of the trade war,” Mizuho Bank analysts said in a note.

“It also resonates with our ‘7-3’ stability threshold hypothesis, which refers to not breaching 7 for dollar-yuan and FX reserves not falling below $3 trillion.”

INTRADAY SWINGING

Prior to the market opening on Monday, the PBOC lifted its official yuan midpoint CNY=PBOC more than expected to 6.8508 per dollar, 202 pips, or 0.3 percent, firmer than the previous fix of 6.8710 on Friday.

The guidance rate was 127 pips higher than Reuters’ estimate of 6.8635 per dollar.

The currency firmed initially in spot trade before swinging between gains and losses.

The offshore counterpart CNH=D3 rose to a high of 6.7818, its strongest since July 31. It traded at 6.8047 as of 0830 GMT.

Traders said the policy move had triggered some dollar selling since Friday night, but gains in the Chinese currency were capped by bargain hunting for cheaper dollars on Monday as many saw strong resistance at 6.8 per dollar for now.

The PBOC introduced the “X” factor in May 2017 when the yuan was firming against a weaker dollar. But Goldman Sachs said it has been used in both direction at various times: to slow yuan gains and to curb yuan losses.

TESTING THE WATERS

Traders suspect the PBOC may already have been testing the waters in recent weeks for a re-activation of the measure as the dollar continued to climb. It was last believed to have been used early this year, when the yuan was firming.

U.S. policymakers look set to continue raising interest rates well into next year, supporting the dollar for a while longer, while China recently started shifting to easier conditions to shore up slowing economic growth.

“How the factor works per se is much less important than the clear signal sent by the PBOC that it would defend 7.0 at least in the next couple of months,” said Larry Hu, head of greater China economics at Macquarie in Hong Kong.

The yuan had appreciated rapidly in the six months after the counter-cyclical factor was first introduced, Hu said.

Late gains in offshore markets after the announcement on Friday spared the currency from an 11th consecutive weekly loss. But it had already posted the longest such losing streak since the exchange rate was unified in 1994.

As of 0830 GMT, the onshore yuan had weakened 4.6 percent against the dollar this year.

Reporting by Winni Zhou and John Ruwitch; Editing by Kim Coghill and Richard Borsuk

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