The People’s Bank of China (PBOC) manages the daily midpoint setting for the yuan, also called the renminbi. The PBOC uses a managed floating exchange rate system. This system allows the yuan’s value to fluctuate within a specific range known as a “band.” This band is set at +/- 2% around the central reference rate.

Recent Update

Recently, the closing rate was noted at 7.1207. With the yuan closing at 7.1207, we are closely watching the daily midpoint fixing for signs of official moves. The key challenge is the PBOC’s goal for stability against the strong US dollar, backed by the Federal Reserve’s “higher-for-longer” interest rate policy announced last week. The difference in interest rates, with US bond yields staying over 200 basis points higher than China’s, naturally pressures the yuan to weaken. For weeks, the central bank has been setting the daily midpoint much stronger than market expectations. This clearly signals its intention to prevent a rapid decline. For example, recent fixes have been around 100 pips stronger than what the market predicted. We saw a similar pattern in late 2023 when the currency was under pressure. This defensive approach indicates that betting on a sudden, uncontrolled drop in the yuan is risky in the short term. The PBOC’s active management is likely to keep volatility low in the coming weeks, keeping the currency within its 2% trading band. Consequently, strategies like selling options to earn premium, such as through short straddles or iron condors on the offshore CNH, could work well. At present, one-month implied volatility is a modest 4.5%, suggesting the market expects a stable environment.

Longer-Term Pressure

While immediate downsides may be limited, weaker economic data, like August’s disappointing 4.1% industrial output, signals longer-term weakening pressure. Thus, we should think about longer-term derivative strategies that bet on gradual depreciation, such as buying 3-to-6 month call options on USD/CNH. This approach lets us prepare for a potential drop while managing risk from the central bank’s daily actions. Create your live VT Markets account and start trading now.

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