Markets

Yuan slips to 6-month low, outlook bearish amid trade friction

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Key Points
  • China's yuan weakened beyond a key 6.6 per dollar level for the first time in six months.
  • The currency recouped some of the losses by midday, but bets are growing for further downside amid an escalating Sino-U.S. trade row.
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China's yuan weakened beyond a psychologically key 6.6 per dollar level for the first time in six months on Wednesday, and though it recouped some of the losses by midday bets are growing for further downside amid an escalating Sino-U.S. trade row.

Reflecting the rising risks to the economic outlook, the People's Bank of China lowered its yuan midpoint for the sixth straight trading day to 6.5569 per dollar, 389 pips or 0.6 percent weaker than the previous fix of 6.5180.

It was the lowest fix since Dec. 25, and the biggest one-day weakening in percentage terms since Jan. 9, 2017, with some analysts suspecting the PBOC prefers to let the currency depreciate modestly.

"The PBOC's preference might be to allow moderate weakening, pulling back if depreciation pressures started intensifying. But that's a difficult balance to strike. The chances of a sizeable depreciation have risen," economists at Capital Economics said in a note.

The spot yuan rate breached 6.6 per dollar level in early trade, after opening at 6.5717 and then moving to a low of 6.6159 at one point, the softest since Dec.19, 2017.

As of midday, the was changing hands at 6.5977, 180 pips weaker than the previous late session close and 0.62 percent softer than the midpoint.

Its offshore counterpart was on track for its tenth straight day of losses, 0.04 percent weaker than the onshore spot at 6.6004 per dollar.

Some dollar selling was seen helping the onshore spot yuan move back up to trade firmer than the 6.6 per dollar level at around midday, several traders said.

However, it wasn't clear if state banks were propping up the yuan, they said.

Major state-owned Chinese banks were seen repeatedly selling dollars to support the yuan after a 2015 devaluation that roiled global markets. These dollar-selling interventions dried up last year.

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Li Liuyang, senior foreign exchange analyst at China Merchants Bank in Shanghai, said the market appears to have been caught out by the Chinese currency's sharp rise at the beginning of this year and the current losses.

"That said there's something wrong with market expectations," Li said, referring to the depreciation expectations.

The year-to-date performance of the yuan "shows that it remains relatively strong rather than weak compared with other G20 currencies," he said.

Li expects limited downside beyond the 6.6 per dollar level given the one-way bets on yuan depreciation isn't as strong as in late 2015 and 2016.

Markets were also speculating whether the central bank had revived the so-called counter-cyclical factor in the midpoint fixing formula after some traders found forecast errors on Tuesday and Wednesday.

The counter-cyclical factor was introduced in May last year to the formula the PBOC used to determine the midpoint reference rate for the yuan's exchange rate against the dollar each day, and it was neutralized in January. Many traders saw it as a tool to reduce price swings and counteract pressure on the yuan.