The People’s Bank of China (PBOC) sets the daily midpoint of the yuan using a managed floating exchange rate system. This allows the currency to fluctuate within a +/- 2% band around the central reference rate. The midpoint is determined each morning, taking into account factors like market supply and demand and international currency fluctuations.
Managing The Yuan’s Fluctuations
The yuan can move within this specified range around the midpoint during a trading day. If the yuan’s value nears the band’s limit or shows excessive volatility, the PBOC may intervene by trading currency to stabilise its value, ensuring a controlled adjustment. The PBOC might adjust the trading band’s size based on economic conditions and policy aims.
We are looking at an expected USD/CNY reference rate of 7.1742 for today. This signals the central bank’s continued effort to manage the yuan’s depreciation against a strong dollar. This level is likely stronger than what market forces alone would dictate, a pattern we’ve seen for many months.
Recent data shows China’s manufacturing PMI for July dipped to 49.5, indicating a slight contraction and ongoing economic softness. This, combined with a struggling property sector, pressures the central bank to keep monetary policy loose. This policy stands in contrast to a US dollar that remains elevated, even with the Federal Reserve pausing its rate hikes.
Volatility And Trading Strategy
Given this managed environment, we anticipate suppressed volatility in the coming weeks. Selling options on the offshore yuan (USD/CNH) to collect premium might be a viable strategy, as the PBOC’s actions limit sharp, unexpected moves. This is because the +/- 2% trading band acts as a ceiling and floor on daily price action.
We saw a similar dynamic throughout much of 2024, where the central bank consistently set strong fixes to counter fundamental economic weakness. During that period, implied volatility on USD/CNH options remained relatively low despite underlying bearish sentiment on the yuan. This historical precedent supports the view that the authorities will prevent a disorderly currency decline.
