Insights 
VT 
The People’s Bank of China (PBOC) sets the yuan’s daily midpoint, as it manages a floating exchange rate system. This system permits the yuan to fluctuate within a +/- 2% range around the reference rate. The reference rate for today is set at 7.1419, while the previous close was 7.1557.
The PBOC conducted operations injecting 789.3 billion yuan via seven-day reverse repos at a rate of 1.40%. With 187.5 billion yuan maturing today, this results in a net injection of 601.8 billion yuan into the financial system.
Central Bank Actions And Yuan Stability
We see the central bank’s action as a clear signal to slow the yuan’s recent decline against the dollar. The significantly stronger-than-expected fixing shows a willingness to defend the currency and push back against market expectations. This move temporarily raises the cost of shorting the yuan directly.
However, we must weigh this against the broader economic data which remains mixed. While China’s industrial output grew a solid 5.6% year-over-year in May 2024, retail sales fell short of forecasts and the property sector continues to slump, signaling persistent domestic weakness. These fundamentals suggest the currency will face renewed downward pressure.
This conflict between policy intervention and economic reality is likely to increase currency volatility in the coming weeks. We believe this makes buying option volatility, such as a USD/CNH straddle, an attractive strategy. This position profits from a large price move in either direction, which seems probable.
Strategies In Current Economic Climate
For those with a directional view, we advise against aggressive bearish positions due to the central bank’s clear stance. A better approach is to use derivatives that define risk, such as buying USD call spreads or CNH put spreads. This allows us to position for eventual yuan weakness while limiting potential losses from further strong fixings.
Looking at history, periods of sustained intervention like we saw in 2018 often slow, but do not reverse, a trend driven by fundamental divergence with the U.S. economy. The large liquidity injection accompanying the fix also points to underlying stress that authorities are trying to manage. We should therefore use any policy-induced strength as a chance to enter bearish positions at more favorable levels.
This currency defense could offer temporary support for Chinese equities, which often benefit from a stable exchange rate. We can use this to sell out-of-the-money call options on indices like the FTSE China A50. This strategy allows us to collect premium based on the view that any stock market rally will be capped by the ongoing economic challenges.
