The People’s Bank of China (PBOC) is likely to set the USD/CNY reference rate at 7.1891, according to a Reuters estimate. The PBOC uses a managed floating exchange rate system to establish the daily midpoint of the yuan against various currencies, primarily the US dollar. This system allows the yuan’s value to change within a +/- 2% band from a set reference rate. The central bank decides this daily midpoint by looking at market supply and demand, economic indicators, and changes in international currency markets.

PBOC Intervention

If the yuan approaches the edges of this trading band or shows large fluctuations, the PBOC may step in. This intervention stabilizes the yuan’s value by either buying or selling it in the market. With the managed float system in place, the daily reference rate becomes a key signal from the PBOC. The Reuters estimate shows an effort to influence the currency’s value instead of letting market forces control it completely. This suggests a strategy aimed at gradual depreciation rather than sudden changes. Traders should pay attention to the ongoing gap between the official midpoint and market expectations. Recently, the central bank has consistently set the reference rate over 1,000 pips stronger than analysts projected. This indicates a strong desire to prevent the yuan from weakening too quickly, creating a predictable resistance level for trading opportunities.

Volatility Strategies

For those who expect continued stability, selling volatility through options strategies like short strangles may be beneficial. The central bank’s commitment to the +/- 2% trading band sets a clear range, lowering the risk of unexpected large moves. In this environment, traders can profit from time decay as long as the currency stays within this managed range. However, it’s important to be ready for potential increases in volatility since the spot rate has recently been close to the weak end of its trading band. Factors like a strong US dollar and worries about China’s property sector could prompt a shift. Buying out-of-the-money puts on the yuan could provide an inexpensive hedge against sudden policy changes or a breakdown in the trading band. Recent economic data paints a mixed picture that supports this managed approach. China’s Caixin manufacturing PMI for May 2024 exceeded expectations by rising to 51.7, suggesting expansion. Yet, ongoing capital outflows and a weak property market require a stable currency. This policy appears to balance the need to help exporters with a weaker currency while avoiding financial instability. Historically, we’ve seen similar strong defensive actions throughout 2023, with the PBOC using its tools to counteract rapid depreciation. This history indicates that the authorities are both willing and able to intervene significantly to achieve their goals. Therefore, betting against the central bank’s ability to support the currency in the short term may not be wise. Create your live VT Markets account and start trading now.

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