The People’s Bank of China (PBOC) sets the yuan’s daily midpoint and manages a floating exchange rate. This means the yuan can move within a +/- 2% range of the reference rate. Today, the reference rate is 7.1419, down from the previous close of 7.1557. The PBOC has injected 789.3 billion yuan into the market through seven-day reverse repos at a rate of 1.40%. With 187.5 billion yuan maturing today, this creates a net injection of 601.8 billion yuan into the financial system.

Central Bank Actions and Yuan Stability

The central bank’s recent actions indicate a desire to slow the yuan’s decline against the dollar. The stronger-than-expected fixing shows its commitment to defend the currency, which temporarily makes it more costly to bet against the yuan. That said, economic data is mixed. China’s industrial output grew by 5.6% year-over-year in May 2024, but retail sales missed forecasts, and the property sector is struggling, indicating ongoing weaknesses. These factors suggest the yuan will face more downward pressure. The tension between government action and economic realities may lead to increased currency volatility in the coming weeks. We think buying option volatility, like a USD/CNH straddle, could be a smart strategy since it profits from significant price changes in either direction, which seem likely.

Strategies in Current Economic Climate

For those with a specific outlook, we advise against taking strong bearish positions due to the central bank’s firm stance. Instead, consider using derivatives that limit risk, like buying USD call spreads or CNH put spreads. This allows you to prepare for potential yuan weakness while minimizing losses from any strong fixing. Historically, sustained interventions, such as those in 2018, tend to slow trends driven by fundamental differences with the U.S. economy but don’t fully reverse them. The large liquidity injection with the fixing hints at underlying stress that authorities want to address. Therefore, use any temporary strength from policy actions as an opportunity to enter bearish positions at better prices. This defense of the currency may provide short-term support for Chinese stocks, which generally benefit from a stable exchange rate. You could consider selling out-of-the-money call options on indices like the FTSE China A50. This strategy allows you to collect premiums based on the view that any stock market rally will be limited by ongoing economic challenges. Create your live VT Markets account and start trading now.

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