The People’s Bank of China (PBOC) determines the daily midpoint for the yuan using a managed floating exchange rate system. This system allows the currency to fluctuate within a +/- 2% range around the central reference rate. Each morning, the midpoint is set based on factors like market supply and demand and international currency trends. **Managing The Yuan’s Fluctuations** Throughout the trading day, the yuan can move within this established range around the midpoint. If the yuan approaches the limits of this band or shows excessive volatility, the PBOC may step in and trade currency to stabilize its value. This intervention helps ensure a controlled adjustment. The PBOC may also change the size of the trading band depending on economic conditions and policy objectives. Today, we expect the USD/CNY reference rate to be 7.1742. This reflects the central bank’s ongoing efforts to manage the yuan’s depreciation against a strong dollar. This reference rate is likely stronger than what market forces would suggest, continuing a trend we’ve observed for several months. Recent data indicates that China’s manufacturing PMI for July fell to 49.5, showing a slight contraction and ongoing economic weakness. This situation, along with a struggling property sector, puts pressure on the central bank to maintain a loose monetary policy. This policy contrasts with a US dollar that remains high, even as the Federal Reserve pauses its rate hikes. **Volatility And Trading Strategy** Given this managed environment, we expect low volatility in the coming weeks. Selling options on the offshore yuan (USD/CNH) to collect premiums could be a smart strategy, as the PBOC’s actions help limit sharp, unexpected market moves. The +/- 2% trading band serves as both a ceiling and floor for daily price action. A similar trend was seen throughout much of 2024, when the central bank regularly set strong fixes to counteract fundamental economic weakness. During that time, implied volatility on USD/CNH options stayed relatively low, despite a generally bearish sentiment towards the yuan. This past behavior supports the belief that authorities will act to prevent a chaotic decline in the currency. Create your live VT Markets account and start trading now.

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