China abandons yuan peg

In July 21, the People’s Bank of China (PBOC) announced it was abandoning its policy of pegging the value of its currency, the remninbi , or yuan, to the U.S. dollar at a fixed rate. From now on the yuan will be linked to a basket of as-yet unnamed currencies (which will include the dollar) and allowed to trade in a daily band of plus or minus 0.3 percent.

The move was an immediate 2.1 percent appreciation in the value of the yuan, from the 8.28 yuan-per dollar rate that had prevailed for the past decade, to 8.11 yuan-per-dollar.

Although the move was widely praised among governments and economists as the first step toward greater flexibility in China’s forex regime, many analysts saw it mostly as a political move aimed mostly at appeasing the U.S. and other trading partners.

As expected, the revaluation of the yuan initially raised the value of Asian currencies, including the yen vs. the dollar.

However, these moves were generally short lived (see “Initial market reaction to Chinese revaluation muddled”). Some analysts doubt China will revalue the yuan again any time soon.

“It seems little further appreciation of the yuan is likely in the near-term, and while some will continue tofocus on basket components and their weights, we doubt that will provide much guidance to movements in the yuan — or in the Euro/dollar or dollar/yen, for that matter,” says Mark Austin, global head of currency strategy at HSBC bank.

Glenn Stevens, managing director of Gain Capital, believes the revaluation moves China in the right direction, much like the Mexican peso adjustment approximately 10 years ago, which unpegged the peso from the dollar and allowed it to float freely. He likens this announcement to lifting the top off a pot of boiling water: While it temporarily relieves some immediate pressure, things are still hot.

Most forex watchers seem to be hedging their bets regarding the longer-term impact of the move.

According to U.K.-based research firm FXToday, “the Chinese move to adjust the yuan will tend todominate in the short term, even though the move is actually fairly limited. Volatility is likely to be a key feature, especially as short speculative yen positions were extreme and this will have a wider dollar impact.”

On July 25, the People’s Bank of China said overnight that foreign media reports calling Beijing’s long awaited boost to its currency last week an “initial adjustment” were incorrect. The statement from China, the main focus for investors, appears to cool expectations of further yuan strength and attendant appreciation in Asian currencies at the expense of the dollar.

“The much-ballyhooed RMB revaluation has come and gone with little perceptible change in major currency rates,” says Brian Dolan, director of research at Gain Capital. “In fact, the revaluation is increasingly being viewed as a non-event, since the scale of the adjustment was the absolute minimum expected and the PBOC does not appear to be willing to allow [it] to actually float within the purported 0.3-percent daily band.

“In the three days of trading since the revaluation to 8.1100, the USD/RMB rate has not been below 8.1097, and the daily range has been around 0.02 percent. This suggests that the PBOC has simply adjusted the RMB slightly higher, but that they will continue to manage it as a fixed-rate peg.”

Dolan adds that the PBOC actions so far indicate the July 21 adjustment was a one-time revaluation and that no further adjustments are contemplated in the “foreseeable future.”

“They are especially concerned that any rush to allow the yuan to float, even if it’s a ‘crawling’ adjustment within the 0.3 percent daily band, would expose the yuan to speculative forces beyond the PBOC’s control,” he says. “Further adjustments are likely to be well down the road and smaller than the market’s expectations. The PBOC has also noted that this revaluation was deliberately small to allow Chinese firms to gradually adjust to a stronger currency.”

Dolan also says this move suggests that continued revaluation speculation in the short-term is likely to be “fruitless,” and that the market has already reverted to the themes that were driving currencies prior to the revaluation, such as widening U.S. interest rate and growth differentials that favor the dollar, and political uncertainty in Japan.