The People’s Bank of China (PBOC) sets the daily midpoint for the yuan, also known as the renminbi. This is part of a managed floating exchange rate system, which allows the currency’s value to shift within a specific range. Currently, this range is +/- 2% around the midpoint. Every morning, the PBOC determines a reference rate by looking at market supply and demand, economic indicators, and global currency trends. This midpoint serves as a guide for trading that day. During trading, the yuan can vary within a +/- 2% band from this midpoint.

PBOC Intervention Tactics

If the yuan’s value approaches the limits of the trading band or shows high volatility, the PBOC may step in. This means they could buy or sell the yuan to keep the market stable. Such actions help manage the currency’s value in a controlled way. The expected USD/CNY midpoint of 7.1743 indicates that the central bank is trying to gradually lower the yuan’s value. Recent weak export data from July showed a 5.1% decline compared to last year, and the unexpected cut to the 1-year MLF rate last week adds more pressure on the currency. We can expect the PBOC to set the daily fix stronger than market expectations to help slow this decline. This situation creates a tension between the central bank’s actions and what the market reflects. The spot USD/CNY rate will likely stay towards the weak end of its 2% daily trading range, showing ongoing demand for the dollar over the yuan. This daily behavior allows traders to use range-based strategies, but there is always a risk of sudden policy changes. For those trading derivatives, this environment suggests that implied volatility might be lower than it should be. Though the PBOC is stabilizing daily price movements, the economic pressure is building, meaning a larger, unexpected move could happen soon. It may be wise to buy low-cost, out-of-the-money call options on USD/CNY to prepare for a possible sharp weakening of the yuan if the authorities choose to allow it.

Historical Context and Future Outlook

Looking back at 2023 and 2024, we saw a similar situation where the Fed’s rate hikes put pressure on the yuan. The PBOC managed to defend the currency then, preventing it from slipping disorderly past the 7.35 mark. This shows the PBOC has both the ability and the will to intervene, but ultimately, economic fundamentals will influence the exchange rate. In the coming weeks, it’s important to monitor the gap between the PBOC’s daily fixing and market expectations. If this gap widens, it signals rising pressure and makes long volatility trades more appealing. We should take advantage of this period of managed stability to set up positions that will benefit from the needed and likely upcoming adjustment in the currency’s value. Create your live VT Markets account and start trading now.

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