The People’s Bank of China (PBOC) set the USD/CNY reference rate at 7.1467, which is lower than the expected rate of 7.1653. This reference rate is crucial for Chinese markets, which have just reopened after a holiday. The PBOC sets a daily midpoint for the yuan and allows it to fluctuate by +/- 2% around this rate. The previous closing rate was higher at 7.1680. Additionally, the PBOC added 495.8 billion yuan through 7-day reverse repos at a rate of 1.40%.

PBOC’s Strategic Moves

With 170.7 billion yuan maturing, this results in a net cash injection of 325.1 billion yuan. The central bank’s decision to set a stronger reference rate than expected clearly signals its intention to support the yuan. This discourages speculation on the currency’s decline and suggests a strategy for stability as markets reopen. Derivative traders should rethink bearish positions on the currency. The significant difference between the official rate and market expectations is likely to lower volatility in the USD/CNY pair in the coming weeks. This creates an opportunity to sell volatility, such as by writing out-of-the-money call options on the dollar against the yuan. The CBOE China ETF Volatility Index (.VXFXI) has dropped over 30% since its peak in January, and this policy move should sustain that trend.

Economic Data and Effects

The effort to stabilize the currency is backed by recent economic data, including first-quarter GDP growth of 5.3%, which was stronger than expected. However, other indicators, like a 26.1% drop in foreign direct investment year-on-year, show the need to maintain investor confidence. A stable currency is essential for that. Historically, strong guidance like this has effectively limited the dollar’s value against the yuan. For example, in the third quarter of 2023, strong fixings preceded a period of stable trading. Traders should expect the central bank to continue using this method to limit significant upward movements in the pair. The liquidity injection directly supports domestic assets. We anticipate that this will ease money market rates and create a positive environment for Chinese equities. Therefore, it may be a good time to consider buying call options on China-focused ETFs, which could benefit from both a stable currency and strong liquidity. Create your live VT Markets account and start trading now.

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