The People’s Bank of China (PBOC) sets a daily midpoint for the yuan, also called the renminbi (RMB), based on supply and demand, economic data, and changes in the global currency market. The yuan follows a managed floating exchange rate system. It can move up or down by 2% from this midpoint each trading day.

Yuan Stability and Intervention

The PBOC may step in if the yuan approaches the limits of its trading range or shows too much price movement. They buy or sell yuan to keep its value steady, ensuring it adjusts gradually. We think the central bank’s main goal is to maintain stability for the yuan. They often set the daily midpoint higher than what the market expects, signaling a desire to slow down its depreciation. This approach suggests the yuan will likely stay within a set range for now. This strategy appears to be a response to mixed economic signals, like the recent report showing China’s manufacturing PMI unexpectedly dropped to 49.5 in May, indicating a contraction. By preventing sharp changes in currency value, officials aim to maintain confidence and avoid rapid yuan depreciation that could lead to capital flight. We see their actions as a way to control the pace of change, not to reverse the trend. For derivative traders, this means that price fluctuations will likely stay low. We should consider strategies that benefit from low volatility, such as selling straddles or strangles to earn premium. The PBOC’s commitment to the +/- 2% trading band acts as a buffer against sudden, large market moves.

Volatility and Risk Management

Historically, times of strong guidance have led to less price movement. For example, implied volatility on one-month USD/CNH options is currently around 3.8%, much lower than during previous market stress. This shows that the market expects stability. The main risk to this outlook would be an unexpected policy change or external events leading the authorities to change their managed float approach. Therefore, we should have strict risk management in place for any short-volatility strategies. A crucial indicator to monitor is the difference between the official midpoint and the actual trading price. We will keep watching the daily reference rate as the key indicator of the PBOC’s intentions. As long as they defend the yuan with strong fixings, we can continue to expect a range-bound strategy. Any significant change in how they set the midpoint would prompt us to reconsider this view. Create your live VT Markets account and start trading now.

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