China has opened a new front in its war to curb currency depreciation by buying up renminbi offshore, foiling the burgeoning carry trade and driving the cost of borrowing to a record high.
The elevated overnight CNH Hong Kong Interbank Offer Rate (Hibor) shows how volatility in China's currency — once a highly domestic sideshow for global investors — is fanning out across the globe through internationalization. Hong Kong, the biggest offshore market, bears the brunt.
It is also a potent sign of the lengths to which China's central bank is prepared to go to support the value of offshore renminbi, known as CNH.
In London afternoon trading on Monday, the offshore renminbi rose 1.2 per cent to CNH6.60, narrowing the divergence with the onshore renminbi, which was up 0.35 percent to CNY6.57.
The overnight CNH Hibor, a daily benchmark for offshore renminbi interbank lending, hit a record-high 13.4 per cent on Monday, up from 4 per cent on Friday and the highest level since the benchmark was launched in 2013. The one-week rate surged from 7.1 per cent to 11.2 per cent.
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The People's Bank of China, acting through state-owned banks in Hong Kong, is buying up renminbi to curb CNH weakness and narrow the gap between CNH and onshore renminbi, known as CNY, analysts say.
The PBOC holds on to its purchases of CNH, thus depleting the supply of CNH available for interbank lending.
By buying CNH the PBOC also frustrates the short-term carry trade designed to profit from weakening renminbi. That trade involves borrowing CNH, exchanging the loan proceeds for foreign currency, then repaying the loan once the renminbi has fallen.
"It looks like PBOC wants to maintain a high cost of shorting CNH," said Zhou Hao, Asia economist at Commerzbank in Singapore.
"On the other hand, it also shows that positioning is quite crowded — everyone borrows CNH to short — which means that a short covering could be very wild if it takes place."
Renminbi deposits in Hong Kong totaled Rmb864 billion ($130 billion) at the end of November, a small fraction of the US dollars available to the PBOC for intervention from its $3.33 trillion stock of foreign exchange reserves.
That means that relatively small interventions in the offshore market can have a major impact on CNH exchange and interest rates.
"With the market still long dollar-renminbi offshore, and the PBOC fixing the onshore rate stable for the second day in a row, it has led to further closing out of long dollar short renminbi positions offshore this morning," said Mansoor Mohi-uddin, market strategist at RBS.
"That short covering led to a spike in CNH Hibor as shorts scrambled for offshore renminbi funding."
Longer-term factors are also contributing to the Hibor spike. CNH deposits have fallen for four straight months, with the decline beginning in August, after the PBOC shocked global markets by loosening its control of the currency, allowing it to depreciate.
As expectations of renminbi weakness built, foreign importers were hoping to offload unwanted renminbi on to their Chinese suppliers through trade settlement.
That led to a flow of CNH back on to the mainland, reducing liquidity.
An uptick in Chinese government bond issuance in the offshore "dim sum" bond market, as well as increased sales of CNH certificates of deposit by Hong Kong banks, have also strained the supply of CNH in recent months.
While CNH Hibor's better-known US-dollar counterpart, Libor, is a crucial benchmark for loans dictating rates on trillions of dollars in funding each day, in CNH Hibor has little practical impact.
Hong Kong banks do not depend on CNH Hibor-linked loans for funding.