Yuan edges up to 1-week high as tight liquidity persists

SHANGHAI: China's yuan edged up to a one-week high against the US dollar on Wednesday, underpinned by persistently tight cash conditions in the interbank money markets which are pushing some closely watched borrowing rates to multi-year highs.

Short-term money rates advanced further to over 21-month highs on Wednesday as investors worried that policymakers may be starting to shift to a tighter stance to cool gains in share prices and property markets.

Prior to the market opening, the People's Bank of China (PBOC) set the midpoint rate at 6.4665 per dollar, 182 pips or 0.28% firmer than the previous fix of 6.4847.

In the spot market, the onshore yuan opened at 6.4630 per dollar and rose to a high of 6.4581, the strongest level since Jan. 21. By midday, it was changing hands at 6.4620, 15 pips firmer than the previous late session close.

Unlike the past few years, the central bank has not been making net liquidity injections into the banking system to meet strong demand for cash heading into the long Lunar New Year holiday.

In fact, it has been draining funds, catching traders by surprise.

Traders said tighter interbank yuan liquidity has prompted fast rises in swap points and added to existing upwards pressure on the yuan. "Against such a backdrop, dollar selling in both spot and forwards markets is increasing," said a trader at a Chinese bank.

As a result, the swap curve in forwards market moved upward.

Signs of liquidity stress onshore also spilled over to the offshore yuan market, according to traders. Yuan borrowing costs rose in Hong Kong on Wednesday morning, with the CNH Hong Kong Interbank Offered Rate benchmark (CNH HIBOR) for overnight tenor rising to a one-week high of 2.98250%.

Traders and analysts expect the yuan was likely to stay strong over the medium- to long-run.

"Overall, we view that the medium- to long-term RMB appreciation drivers as being largely intact," said Terence Wu, FX strategist at OCBC Bank.

"However, this theme may have slightly weakened compared to where it was at the start of 4Q 2020, on the count of reduced gap between in relative growth and yield differentials," he said, expecting the yuan to consolidate between 6.44 to 6.5 per dollar for now and potentially targeting levels south of 6.3 by year end.

Separately, traders were awaiting comments later from US Federal Reserve Chair Jerome Powell, who is likely to renew a commitment to ultra-easy policy. His remarks could affect the dollar and other currencies.

The global dollar index rose to 90.24 at midday, while the offshore yuan was trading at 6.4698 per dollar.