The People’s Bank of China (PBOC) sets the daily midpoint for the yuan. This midpoint is part of a managed floating exchange rate system, allowing the yuan to move within a specific range centered around a reference rate. Currently, the trading band is set at +/- 2%, which limits how much the yuan can change in one day. Each morning, the PBOC determines this midpoint in relation to several currencies, with a focus on the US dollar, while considering market trends.

Yuan Movement Limitations

The yuan can only fluctuate within the +/- 2% band around this midpoint. If the yuan approaches these limits or becomes too volatile, the PBOC might step in to stabilize it. The PBOC might buy or sell yuan to keep its value in check. This method allows for slow, controlled changes in the yuan’s value based on economic conditions and policy goals. The market expects the yuan’s reference rate to be 7.1479, indicating a trend of gentle depreciation. This is influenced by ongoing pressures, like the interest rate difference between the US and China. US 10-year yields are about 4.3%, while China’s are at 2.4%. This makes holding US dollars more appealing, which can cap the yuan’s value. We need to monitor the daily midpoint against market expectations in the coming weeks. In 2023 and 2024, the central bank often set the daily midpoint stronger than expected to slow the yuan’s decline. If this trend continues, it shows an official intent to keep the currency stable and prevent it from weakening too quickly.

Investment Strategies In Yuan Environment

In this managed environment, implied volatility for derivatives may be too high. Recently, one-month USD/CNH implied volatility reached 4.5%, but due to the PBOC’s tight control, a sudden large change is unlikely. Strategies like selling option strangles or straddles could work well to take advantage of this expected stability. Holding long USD/CNY positions through the forward market also remains appealing. The interest rate difference means traders earn money by holding dollars against the yuan. This strategy is effective if we expect the central bank to allow steady depreciation rather than a major strengthening of the yuan. A major risk to this outlook would be unexpected policy changes from Beijing to stimulate the economy or weaker US economic data that changes interest rate predictions. We noticed how quickly sentiment shifted after surprise policy announcements in late 2024. Therefore, employing defined-risk strategies, like buying USD/CNY call spreads, might be a wiser way to express a bullish view on the dollar. Create your live VT Markets account and start trading now.

here to set up a live account on VT Markets now