The People's Bank of China set the yuan midpoint at 6.3375 before the market opened after the dollar index tanked in overnight trade, dropping nearly 100 basis points in global markets as disappointing US economic data led traders to bet that more quantitative easing -- which puts downward pressure on currency values -- is on the way.
Spot prices opened stronger than the midpoint at 6.3370 and stayed above the midpoint by midday, part of a new trend that began last week when yuan spot prices began to consistently cross to trade stronger than the midpoint for the first time since March.
The trading band for spot prices was widened in April to 1 percent from 0.5 percent, but exploration of the new range was mainly confined to the weak side until recently.
Traders said the PBOC was initially concerned at the rate of yuan depreciation that ensued after the band was widened. It deliberately set higher midpoints than the market was comfortable with, they said, to signal it would not allow depreciation to become so abrupt as to destabilise markets.
However, as corporates successfully unwound short-dollar positions by the end of the first half, market-driven depreciation pressure on the yuan eased, leading to the current equilibrium in which the spot price remains in a narrow range between 6.33 and 6.35.
Chinese leaders, facing intensified concern that the domestic economy is having difficulty weather sustained weakness in its exports markets, have said that Beijing will take steps to support exporters, which many interpreted as an official endorsement of a weakening trend in the yuan.
However, Guo Jianwei, deputy director of the central bank's monetary policy department, said the yuan's current equilibrium suggested that the trading band could be widened again to allow the yuan to better reflect market forces.
Speaking on the sidelines of an investment forum in Xiamen, Guo said the yuan's new-found volatility had reduced the incentive for speculators to long yuan on the assumption the only direction it could go was up.
Guo also said it was a good time for Chinese firms to make overseas investments in yuan to hedge against exchange rate conversion risks. Such investment would also help increase the global status of the Chinese currency.
"Our dream of developing the yuan into a more commonly used global currency is taking shape and I think we have the conditions to realise it eventually," he said.
Traders told Reuters that they see limited upside room for the yuan to appreciate against the dollar this year, given the state of the domestic economy, in particular weakness in exports, which would be aggravated by strengthening movements in the yuan.
OFFSHORE AND FORWARDS
Forwards contracts continue to trade at a discount to spot prices.
The offshore 1-year non-deliverable forward (NDF) contract changed hands at 6.4170 in midday trade, softer than the spot price but narrowing the previous trading day's spread by over a basis point.
Onshore 1-year deliverable contracts also strengthened but not as strongly as the NDFs, trading at 6.4619.
While many read the discounted prices as expressions of depreciation expectations, interest rate differentials have begun to play a more important role in forwards pricing as money begins to flow more freely across Chinese borders.