The People’s Bank of China (PBOC) has set the USD/CNY reference rate at 7.1511. Analysts had predicted this rate would be 7.1891. This rate is part of China’s managed floating exchange system, which lets the yuan vary by +/- 2% around a central value. The last closing rate was 7.1787.

Liquidity Management

Along with setting the exchange rate, the PBOC added 449.2 billion yuan to the financial system using 7-day reverse repos at an interest rate of 1.40%. Today, 214.8 billion yuan is maturing, leading to a net injection of 234.4 billion yuan. These actions show the PBOC’s commitment to managing liquidity and maintaining the currency’s value. We view the central bank’s decision as a clear statement that they will protect the yuan and prevent rapid depreciation. The fixing was set much stronger than expected, indicating a strong commitment to stability. This sends a message to traders not to bet against the yuan. At the same time, the significant net liquidity injection indicates a focus on supporting the domestic economy. The PBOC aims to keep borrowing costs low to encourage growth while managing the currency’s external value. This means we shouldn’t see the strong currency stance as a sign of tighter overall monetary policy.

Deflationary Pressures

This supportive policy is crucial, as recent data shows ongoing economic weakness. China’s Producer Price Index (PPI), which tracks factory prices, dropped 1.4% in May, marking 20 straight months of decline. These deflationary trends give the bank every reason to maintain ample liquidity, even while supporting the yuan. For derivative traders, these predictable and strong fixings aim to reduce currency volatility. We believe the best strategy is to sell volatility, particularly by writing short-dated call options on the USD/CNY pair. This position benefits from the currency staying stable or slightly strengthening, which is what the authorities are working toward. This approach contrasts sharply with the market shock during the 2015 devaluation. Today’s actions are clear and systematic, designed to shape expectations rather than catch the market off guard. Therefore, we should trade in alignment with policy, expecting a managed and gradual change in the exchange rate. The underlying pressure on the currency persists due to policy differences with the United States. With the Federal Reserve likely to keep interest rates high, the US dollar remains strong, creating a fundamental challenge for the yuan. The significant interest rate gap is the main reason the central bank must intervene so forcefully and consistently. Create your live VT Markets account and start trading now.

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