The People’s Bank of China (PBOC) sets the daily midpoint for the yuan or RMB, mainly against the US dollar. This is part of a managed floating exchange rate system, allowing the yuan to fluctuate within a set range or “band” around a central rate. The current band is +/- 2%.
Each morning, the PBOC establishes a midpoint considering factors such as market supply and demand, economic indicators, and global currency market changes. This midpoint acts as a reference for trading throughout the day. The PBOC allows the yuan to move within +/- 2% of this midpoint. This range helps manage the currency’s value in response to economic and policy requirements.
Intervention Strategies
In cases where the yuan’s value nears the trading band’s limit or shows high volatility, the PBOC may intervene by buying or selling the yuan. These actions help maintain a stable and controlled adjustment of the currency’s value.
We observe the central bank is consistently setting the daily reference rate significantly stronger than market expectations. This action demonstrates a clear policy to lean against rapid currency depreciation. This deliberate management effectively creates a ceiling on how high the dollar can trade against the yuan on any given day.
This policy stands in contrast to underlying economic pressures that suggest the currency should be weaker. For example, China’s official manufacturing PMI recently fell to 49.5 in May 2024, indicating a contraction in factory activity and highlighting persistent weakness in domestic demand. This fundamental economic reality creates a continuous headwind for the currency.
Trading Strategies
The conflict between policy intervention and economic fundamentals is keeping short-term, or realized, volatility unusually low. For derivative traders, this means strategies that profit from a stable or slowly grinding market may be advantageous. We believe the risk of a sudden, sharp move is being actively suppressed by the authorities.
Historically, after the market turmoil following a surprise devaluation in 2015, the authorities have preferred a very gradual and controlled approach to currency adjustments. This precedent reinforces our view that the current strategy of using the daily fixing to manage the pace of depreciation will continue. A sudden break of the trading band is therefore unlikely in the near term.
Given this environment, we see value in selling out-of-the-money USD/CNY call options. This strategy benefits from the passage of time and the central bank’s firm grip on the exchange rate, which limits the potential for a sharp upward spike. The position is designed to profit from the current low-volatility, managed regime.
We should also consider calendar spread strategies for options trading. This involves buying a longer-dated option while selling a shorter-dated one, betting that while the currency remains stable now, the underlying pressures will eventually force a larger move. This approach allows traders to position for future volatility while benefiting from the current stability.
