Recent actions by China's central bank have cemented a new reality for traders: one where bets for yuan depreciation go head-to-head with government stabilization efforts in a new "managed float" regime.
On Friday the People's Bank of China (PBoC) snapped a three-day streak of weaker yuan fixings, setting the currency at 6.3975 per dollar versus the previous close of 6.3990, after officials effectively quashed expectations for continued currency falls at a press conference on Thursday.
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Friday's stronger fix was the latest sign of just how serious PBoC officials are about preventing extended depreciation, traders said. Late on Thursday, Reuters reported that the PBoC asked state banks to buy more yuan on its behalf for a second straight day.
This may mean the spell of aggressively weaker fixings is over, for now, at least.
"Authorities signaled on Thursday that they are comfortable with the yuan's approximate 3 percent depreciation this week, and now that the spot rate has converged to the fix for the first time since November, we can expect a period of more stability in fixes," Khoon Goh, ANZ's senior FX strategist, told CNBC.
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So now that the central bank is happy with the yuan's position, does this mean the end of intervention? Not quite.
"It all depends on how the market trades. As long as the spot behaves and trades around the 6.40 level, officials should be more comfortable and refrain from stepping in," Goh continued.
Experts widely agree that Beijing isn't allowing the yuan to be free floating for now; rather it's embracing a managed floating regime, one characterized by more flexibility and calculated intervention.
"Going forward, the closing spot rate will probably represent the official view, while the bias of the fixing relative to the closing rate may reflect the bias of the market," Citi explained in a note on Thursday.
The PBoC's tolerance level may be between 6.3-6.4 per dollar, judging by intervention levels, the bank added.
Managing expectations
The PBoC's actions this week has heightened confusion about its tolerance for market forces.
On Thursday central bank deputy governor Yi Gang simultaneously tempered run-away currency depreciation expectations and confirmed the role of market supply and demand in exchange rate formation. But it remains to be seen whether the central bank can really pull off this balancing act.
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"Who should we believe - government or market?" asked Citi. "The PBoC official said it would respect the market, but the market may want to see more depreciation in the near term," revealing how difficult it will be to achieve equilibrium between regime flexibility and currency stability.
Indeed, the extent of depreciation bets remains elevated.
The PBoC's statement that "the fixing adjustment process is basically complete," i.e. the yuan's approximate 3 percent depreciation since Tuesday was sufficient, can't be taken seriously, JPMorgan analysts pointed out in a Thursday report.
"Just like the one-off devaluation wording used on August 11, this is a backward-looking statement. It does not rule out the possibility of further depreciation if driven by new market developments."
Mizuho economists echoed that view.
"The policy bias is to prevent the RMB from spiraling out of control, but a market-based approach still implies a weaker RMB given continued depreciation expectations," they said in a Friday note.
ING is forecasting the currency to trade 6.55 per dollar by year end, while Citi is predicting 6.8 and Mizuho is anticipating levels between 6.50-6.60.
Going forward, "it will be worth watching what further actions the PBoC may take from here, including communications, window guidance, strengthening monitoring on FX transactions or intervention," JPMorgan said.
