The People’s Bank of China (PBOC) oversees the daily midpoint value of the Chinese yuan, also called renminbi (RMB), using a managed floating exchange rate system. This system allows the yuan’s value to change within a specific range, or “band,” set at +/- 2% around a central reference rate. Every morning, the PBOC establishes a midpoint for the yuan against a mix of currencies, mainly the US dollar. They consider market demand, economic indicators, and shifts in international currency markets. This midpoint serves as a guide for daily trading.

Yuan’s Value Fluctuation

Each trading day, the yuan can vary within a +/- 2% range from the midpoint, leading to both increases and decreases in value. The PBOC may modify this range depending on current economic conditions and goals. If the yuan approaches the limit of this band or shows high volatility, the PBOC steps in to stabilize it. They do this by buying or selling the yuan, which helps manage the currency’s value steadily and keeps the market stable. Currently, the People’s Bank of China seems to be pushing for a stronger yuan, as today’s reference rate is consistently higher than market expectations. This approach aligns with the belief that the U.S. Federal Reserve may start easing its policies soon. This situation signals that the dollar may weaken against the yuan in the weeks to come. Given this perspective, we are considering buying put options on the USD/CNH pair, which benefit when the dollar weakens against the offshore yuan. Implied volatility is low, suggesting the market expects a steady decline rather than a sharp fall. This makes it a good time to buy options before any unexpected policy changes could increase volatility.

Global Implications and Trading Strategies

Recent data shows that U.S. core inflation has dropped to 2.1%, which might allow the Fed to cut rates after the highs seen in 2024. The market is anticipating at least two rate cuts by the end of this year, a significant shift from the aggressive rate hikes of 2022-2023. The USD/CNY pair has already fallen from the 7.30 range in late 2023 as this policy difference has become apparent. We see this trend as part of a larger theme, not just a situation in China, since a stronger yuan often supports other emerging market currencies. The MSCI Emerging Markets Currency Index has gone up 3% in the past quarter, suggesting growing risk-taking. Thus, we are also looking at long positions in currencies like the Korean won and the Mexican peso against the dollar as a strategy. It’s essential to keep in mind the PBOC’s +/- 2% daily trading band. This ensures that any changes will happen gradually rather than suddenly. The central bank is guiding this appreciation and not allowing the market to fluctuate freely. This points to a strategy of holding positions over several weeks instead of expecting an abrupt revaluation overnight. Create your live VT Markets account and start trading now.

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