Analysis-After battle with yuan bears, China is now keen to avoid sharp currency gains By Reuters

SHANGHAI (Reuters) – After spending a year trying to put a floor under the slumping yuan, China’s central bank is suddenly facing the opposite problem and is resorting to underhanded means to prevent the currency from rising sharply.

The Chinese yuan, which is usually pegged, rose 1.3% against the dollar in August, recouping almost all of its losses in the first half of the year, and on Friday it looked set to post its fifth straight weekly gain, its longest streak in more than three years.

Although none of the fundamental domestic drivers, particularly a weak economy and capital flight, have changed, the yuan has been supported by growing bets on interest rate cuts by the US Federal Reserve, which weakens the dollar, and a stronger Japanese yen.

Meanwhile, Chinese authorities have been working behind the scenes to ensure the currency does not appreciate abruptly, which could destabilize fragile domestic financial markets and hurt exporters. They have been surveying the market to gauge pressures, and quietly easing restrictions on gold imports and yuan trading positions for some banks.

“The government may be less concerned about currency depreciation but remains cautious about exchange rate volatility,” said Gary Ng, chief economist for Asia-Pacific at Natixis.

“While pressure on the yuan may ease with the possibility of the US Federal Reserve finally cutting interest rates, there could be sudden and large movements in capital flows.”

One of the main reasons the People’s Bank of China is concerned is the buildup of short-term speculative positions in the yuan during the currency’s steady decline since early 2023, which could be unwinded in a chaotic manner if the currency rises rapidly.

Foreign companies operating in China, local exporters and investors have swapped yuan for dollars to achieve better returns in what is known in market circles as yuan trading.

Analysts at Macquarie Group (OTC) estimate that exporters and multinationals have accumulated more than $500 billion in foreign exchange reserves since 2022.

“As the yuan appreciates… there may be concerns about the potential for a yuan carry trade to unwind and shocks to financial markets,” said Zhou Zhaoping, global market strategist at JPMorgan Asset Management.

“Perhaps the recent volatility in the Japanese market has reminded policymakers of these risks.”

China’s currency regulator, the State Administration of Foreign Exchange, and the People’s Bank of China did not respond to Reuters requests for comment.

Prevent stampede

Perhaps to get a sense of the pent-up yuan buying that could come with a stronger currency, the State Administration of Foreign Exchange surveyed banks on their clients’ foreign exchange conversion ratios — the percentage of revenues exporters convert into yuan — last week, two people with direct knowledge of the matter told Reuters.

“Foreign exchange settlement is the issue that everyone in the market is worried about, along with the Fed’s interest rate cut,” said Liu Yang, general manager of the financial market business department of Chengdu Mineral Export Development Group.

“After all, exports are the only major driver of the Chinese economy among the traditional ‘troika’ (traditional growth engines), and regulators do not want the yuan to appreciate so quickly and so dramatically that it would weaken the competitiveness of export products,” he added.

Separately, guidance given to banks last year prohibiting them from holding short positions in yuan at the end of the trading day has been eased for some banks, two people with direct knowledge of the matter told Reuters.

Reuters reported that the central bank has given Chinese banks new quotas for importing gold. Gold imports are usually reduced when the yuan faces pressure to depreciate.

Analysts said the moves were subtle and, along with the trend in the People’s Bank of China’s daily reference guidelines for the yuan, simply indicated a desire to contain volatility, rather than forestall gains.

However, market participants continue to revise their expectations for the yuan.

Analysts at Bank of America Securities expect the yuan to continue to weaken “given weak growth and the People’s Bank of China’s monetary easing,” but they see the yuan at 7.38 per dollar by year-end, not 7.45 as they previously forecast. It’s currently trading at about 7.14 per dollar.