The People’s Bank of China (PBOC) set the USD/CNY reference rate at 7.1467, under the anticipated rate of 7.1653. This reference rate is pivotal for Chinese markets, reopening after a holiday break.
The PBOC establishes the daily midpoint for the yuan, permitting a fluctuation range of +/- 2% around this reference. The previous closing rate was higher at 7.1680. Additionally, the PBOC infused 495.8 billion yuan using 7-day reverse repos with a rate of 1.40%.
pboc’s strategic moves
With 170.7 billion yuan maturing, this led to a net cash injection of 325.1 billion yuan.
We see the central bank’s decision to set the reference rate significantly stronger than market estimates as a clear signal of its intent to support the yuan. This action discourages bets on currency depreciation and suggests a strategy to manage stability as markets reopen. Derivative traders should therefore reconsider outright bearish positions on the currency.
The large gap between the official fixing and market expectations will likely suppress realized volatility in the USD/CNY pair over the coming weeks. We believe this creates an opportunity to sell volatility, for instance, by writing out-of-the-money call options on the dollar against the yuan. The CBOE China ETF Volatility Index (.VXFXI) has declined over 30% since its January peak, and this policy move should reinforce that trend.
economic data and effects
This move to stabilize the currency is supported by recent economic data, including a stronger-than-expected first-quarter GDP growth of 5.3%. While this provides a solid foundation, other indicators like foreign direct investment, which fell by 26.1% in the first quarter year-on-year, highlight the need to maintain investor confidence. A stable currency is a key component of that strategy.
Historically, such forceful guidance has effectively placed a temporary ceiling on the dollar’s value against the Chinese currency. We saw a similar pattern in the third quarter of 2023, where strong fixings preceded a period of range-bound trading. Traders should anticipate that the central bank will continue to use this tool to cap any significant upside moves in the pair.
The accompanying net liquidity injection is a direct and supportive measure for domestic assets. We expect this will soothe money market rates and provide a positive environment for Chinese equities. Consequently, this could be a good time to look at buying call options on China-focused ETFs, which benefit from both a stable currency and ample liquidity.
