China's yuan firms past guidance rate for first time since March

HONG KONG/SHANGHAI: China's currency crossed the central bank's daily midpoint for the first time since March on Wednesday, as traders pushed the yuan back toward bullish territory after a weak first half, potentially preparing the ground for robust gains in the second.

The move also marks the first time since September 2012 that the spot rate has crossed the midpoint to the strong side of the central bank's guidance rate ; in 2012 that set off a long-running rally that lasted into early 2014.

The yuan's smart gains since late May come in the face of signals from the People's Bank of China (PBOC) that it wants to keep the currency stable for now.

At the same time, the newly-widened trading band -- increased to 2 percent from 1 percent in March -- has given the market increased latitude to price the currency as it sees fit.

That has introduced more risk into the market but also reduced the traction the midpoint fix has over pricing.

"The spot rate converging with the midpoint is consistent with the meaning of 'bi-directional volatility,'" said a trader at a European banker in Shanghai, referring to the stated reason for widening the trading band given by regulators. "However, this doesn't mean the resumption of one-way appreciation, or that market participants have changed their expectations regarding the yuan's future trend. It just represents the end of the sharp depreciation experienced earlier

this year."

The yuan's recent rally, supported by signs of recovery in exports, has wiped out part of the 3.3 percent of losses incurred at the depth of its weakness in late April.

That was when the PBOC punished speculators by engineering a dramatic and sustained decline in the exchange rate. At that point, the spot rate was trading at a record 1.7 percent weaker than the official guidance rate.

The yuan's slide not only discouraged hot money inflows and caused short-term speculators to bail out of leveraged long-yuan positions, but also generated losses at Chinese companies such as airlines which had bet heavily on further appreciation.

It also garnered criticism from the US government, which has consistently complained that Beijing keeps the yuan undervalued.

OUTLOOK FIRMER

A research report by China-focused investment bank NSBO in Beijing said the government's attempts to drive out speculation had caused many investment funds targeting China to "park" funds temporarily in the United States.

The process is now reversing on signs China's manufacturing and exports are recovering, and seen providing deeper support to the yuan's rally.

"We expect moderate appreciation of the RMB overall in H2, mainly due to the market rate shifting above the PBOC set rate rather than any significant move by the PBOC," authors of the NSBO report wrote.

"The central bank may, instead, have to intervene more aggressively again to keep up the threat of greater volatility to deter another round of speculative inflows."

The renminbi's previous underperformance stands out starkly if seen through the lens of the Sharpe ratio, which takes into account percentage returns of the currency minus risk-free rate returns adjusted for currency standard deviation or swings.

Using that metric, the Chinese currency has notched up a ratio of minus 2.2, the worst six-month performance since the second half of 2010, according to Thomson Reuters data.

In comparison, on a Sharpe-ratio basis, the renminbi posted a rate of return of 2.8 in the corresponding period of last year.

A more bullish currency outlook will change the decision-making environment for the central bank, which must consider the impact a major resumption of cash inflows would have for economic stability, and for Chinese firms evaluating their currency strategy.

For companies that make heavy purchases in dollar-denominated assets such as fuel, a stronger yuan is a benefit: Chinese airline stocks have been rallying again as the yuan has risen, for example.

It should also support corporate interest in the offshore yuan markets and encourage firms to settle trade in yuan in the hope of further appreciation.