The People’s Bank of China (PBOC) is the central bank that sets a daily midpoint for the yuan, also known as the renminbi (RMB). This system uses a managed floating exchange rate, allowing the yuan to fluctuate within a specific “band” around a reference rate. Every morning, the PBOC determines the yuan’s midpoint based on a basket of currencies, primarily the US dollar. This midpoint is affected by market supply and demand, economic indicators, and trends in international currency markets. The trading band permits the yuan to shift within +/- 2% of the midpoint. This means the yuan can rise or fall by up to 2% from the midpoint during each trading day. If the yuan approaches the band limits or shows excessive volatility, the PBOC may step in. They can buy or sell the currency to stabilize its value, helping to control its fluctuations. This system allows the PBOC to guide the yuan’s direction while still giving the appearance of a market-driven rate. The daily midpoint adjustments reflect short-term currency trends without losing overall control. Traders expect this mixed approach — a visible anchor with hidden limits. When the yuan nears the band limits, it often leads to speculation about possible intervention. This speculation can cause short-term fluctuations and increased trading volumes, especially in offshore markets where reactions can be swift. In the past, central bank actions have not only affected the yuan directly but also had broader impacts on risk indicators in Asia. Recently, the midpoint settings have shown a consistent pattern that doesn’t match market expectations. The reference rates have been stronger than what spot markets suggest, indicating that authorities are trying to prevent depreciation. This is typically seen as a policy choice to maintain currency stability, possibly to reassure foreign investors or manage capital outflows. We see this as a call for careful risk management during times of cash flows in Asia. For those involved in currency derivatives, like options or non-deliverable forwards, the key focus is not just on levels but on the trends and consistency between official rates and market quotes. We’re closely monitoring this gap, as it indicates intent — traders should be cautious of straying from it. A series of stronger fixes can influence implied volatility, especially if traders decide to unwind dollar-long positions. Chen’s recent comments about keeping yuan flexibility while maintaining a solid anchor reinforce this approach. While the rhetoric was calm, the message was clear: short-term fluctuations are acceptable, but they are actively working against long-term depreciation. This implies that positions heavily betting on yuan weakening might be at risk in the coming weeks. Market depth has also been thinner than usual during early Asian trading hours, which makes pricing more prone to sudden changes. Those using leveraged strategies may need to reevaluate their hedging thresholds, as assuming volatility will stay low could be a mistake, especially if official guidance continues to differ from current realities. We are closely examining the basket composition and trade-weighted references, particularly with recent weakness in the euro and yen. If the central bank starts focusing less on dollar parity and more on overall competitiveness, this could change expectations on how the midpoint is managed. That adjustment may also impact curve spreads during times of low liquidity. Finally, it’s noteworthy that domestic corporates are shifting back towards hedged exposures in the onshore forward market. This subtle signal, often missed, combined with a firmer fixing tone, suggests a lower tolerance for one-sided market trends. This indicates we should keep our positions flexible and limit bias until we observe clearer patterns in the daily midpoint adjustments.

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