The People’s Bank of China (PBOC) sets the daily midpoint for the yuan, or renminbi (RMB), against a group of currencies, mainly the US dollar. The PBOC oversees a floating exchange rate system, allowing the yuan’s value to change within a range of +/- 2% around this central rate. This approach considers market demand, economic indicators, and fluctuations in international currency markets.

Yuan Trading Band

The midpoint acts as a guide for daily trading, setting the boundaries for how much the yuan’s value can change. The trading band lets the yuan rise or fall by a maximum of 2% from the central rate each day. The PBOC may adjust this band based on changing economic circumstances and policy objectives. To maintain stability, if the yuan nears the band limits or experiences too much volatility, the PBOC might step in. It can buy or sell yuan to stabilize its value, ensuring a balanced market. This daily reference rate is not just a number but an important policy signal. Traders should pay attention to the difference between this official rate and what the market expects. This gap indicates the central bank’s true intentions regarding the yuan’s direction. There is a noticeable trend where the PBOC sets the midpoint significantly stronger than expected. For example, on June 7, 2024, the official midpoint was 7.1106, over 1,300 pips stronger than the Reuters estimate of 7.2455. This strong adjustment shows a clear intent to support the yuan and guard against rapid depreciation. This firm approach likely responds to domestic economic issues and aims to reduce capital outflows. By setting a stronger-than-anticipated currency, the bank conveys stability and confidence in its financial system. We expect this concept of tightly managing the currency to continue amid ongoing economic uncertainties.

Impact On Derivative Traders

For derivative traders, this strict management effectively creates a cap on the USD/CNY exchange rate. We suggest selling call options or setting up bearish call spreads as smart strategies since they profit from the currency pair’s limited ability to rise significantly. These strategies align perfectly with the observed policy of limiting upward movement. The PBOC’s actions also directly affect market volatility, which has been relatively low. Because of this, strategies relying on price swings, like buying straddles or strangles, seem less effective right now. Instead, we see an opportunity in selling volatility, as the bank’s interventions are likely to keep prices confined within a small range. Historically, during economic downturns, such as in 2018, the PBOC has followed this strategy to guide currency values. Betting against this determined policy often leads to losses in the short to medium term. We believe this trend will continue in the coming weeks. We recommend keeping an eye on the difference between the onshore yuan (CNY) and the more freely traded offshore yuan (CNH). If this gap widens, with the offshore rate weaker, it signals increasing market pressure for depreciation. This will be our main indicator of how much stress the bank’s policy is under. Create your live VT Markets account and start trading now.

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