The People’s Bank of China (PBOC) sets a daily midpoint exchange rate for the yuan (RMB), mainly against the US dollar. This process is part of a managed floating exchange rate system that allows the yuan to fluctuate within a specific range, or “band,” around the central rate. Currently, this range is +/- 2%. Each morning, the PBOC determines the midpoint based on market supply and demand, economic indicators, and changes in global currency markets. This midpoint serves as a reference point for trading throughout the day. The PBOC permits the yuan to change within +/- 2% of this midpoint, helping to manage its value in line with economic and policy needs.

Intervention Strategies

When the yuan approaches the limits of this trading band or experiences high volatility, the PBOC may step in by buying or selling yuan. These actions aim to keep the yuan’s value stable and controlled. The central bank often sets the daily reference rate stronger than market expectations. This move shows a clear intent to counter quick drops in the yuan’s value. Such management effectively caps how high the US dollar can go against the yuan on any given day. This policy contrasts with economic pressures that might suggest a weaker yuan. For instance, China’s official manufacturing PMI fell to 49.5 in May 2024, signaling a decrease in factory activity and ongoing weakness in domestic demand. This fundamental economic situation creates a persistent challenge for the currency.

Trading Strategies

The conflict between policy intervention and economic fundamentals keeps short-term volatility unusually low. For derivative traders, strategies that benefit from a stable or slowly changing market could be profitable. We believe that authorities are actively suppressing the risk of sudden sharp movements. Historically, after market turmoil from an unexpected devaluation in 2015, officials have favored a slow and controlled approach to adjusting the currency. This history supports our view that the current tactic of using daily fixing to manage depreciation will persist. A sudden break of the trading band is unlikely in the near future. Given this situation, we see value in selling out-of-the-money USD/CNY call options. This strategy takes advantage of time passing and the central bank’s control over the exchange rate, which reduces the chance of a rapid increase. This position aims to profit from the current low-volatility, managed environment. We should also explore calendar spread strategies in options trading. This involves purchasing a longer-dated option while selling a shorter-dated one, betting that although the currency is stable now, underlying pressures will eventually lead to a larger movement. This approach allows traders to prepare for future volatility while reaping benefits from the current stability. Create your live VT Markets account and start trading now.

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