Big news coming out of Asia today as China has dropped it’s reference rate by 1.9% causing a spike in USD/CNH and big losses for other renminbi pairs. Reminiscent of the Swiss Franc spike back on January 15th, those lucky enough to still be holding long positions on USD/CNH have seen a huge increase in their account values this morning as USD/CNH has rocketed over 1,000 pips.
China devalued the yuan by the most in two decades, ending the most recent de facto trading band to the dollar that’s been in place since March and battered exports. The People’s Bank of China cut its daily reference rate for the currency by a record 1.9%, triggering the yuan’s biggest one-day loss since China unified official and market exchange rates in January 1994.
Click here to read official ‘PBOC Questions on Improving Quotation of the RMB Central Parity’, a snippet from the Q & A states, “…the reform of RMB exchange rate formation mechanism will continue to be pushed forward with a market orientation. Market will play a bigger role in exchange rate determination to facilitate the balancing of international payments. Foreign exchange market development will be accelerated and foreign exchange products will be enriched. In addition, the PBC will push forward the opening-up of the foreign exchange market, extending FX trading hours, introducing qualified foreign institutions and promoting the formation of a single exchange rate in both on-shore and off-shore markets.”
The change today was a one-time adjustment, the central bank said in a statement, adding that it plans to keep the yuan stable at a “reasonable” level and will strengthen the market’s role in determining the fixing. China has been aggressive about promoting the RMB as an international currency, is this the first step to allowing the currency to truly have a free float? If that is even possible with the Chinese regime, the USD/CNH pair could eventually come to rival the volume similar to that of EUR/USD and other majors.
“It looks like this is the end of the fixing as we know it,” said Khoon Goh, a Singapore-based strategist at Australia & New Zealand Banking Group Ltd. “The one-off devaluation of the fix and allowing more market-based determination takes us into a new currency regime.”
The PBOC had been supporting the yuan to deter capital outflows and encourage greater global usage as China pushes for official reserve status at the International Monetary Fund. The intervention contributed to a $300 billion slide in the nation’s foreign-exchange reserves over the last four quarters and made the yuan the best performer in emerging markets, eroding the competitiveness of Chinese exports.
The currency dropped 6.3550 per dollar in Shanghai trading hours, and slid over 2% percent in Hong offshore trading, designated by CNH instead of the onshore CNY symbol.
China has to balance the need to boost exports with the risk of a cash exodus, Tom Orlik, chief Asia economist at Bloomberg Intelligence, wrote in a research note. He estimates a 1 percent depreciation in the real effective exchange rate boosts export growth by 1 percentage point with a lag of three months. At the same time, a 1 percent drop against the dollar triggers about $40 billion in capital outflows, he wrote.
“The risk is that depreciation triggers capital flight, dealing a blow to the stability of China’s financial system,” Orlik wrote. The calculation from China’s leaders is that with their $3.69 trillion of currency reserves “they can manage any risks from capital flight,” he said.
To read more about the move from the PBOC from Bloomberg, click here.