The People’s Bank of China (PBOC) sets a daily midpoint for the yuan, also known as the renminbi. This system allows the yuan’s value to fluctuate within a “band” of +/- 2% around this midpoint. Each morning, the PBOC determines the daily midpoint based on market factors like supply and demand, economic data, and international currency movements. This midpoint guides yuan trading for the day.

Yuan Midpoint and Trading Band

The yuan can change within a +/- 2% range of the midpoint, allowing for its value to go up or down. The PBOC can adjust this range depending on economic conditions and its goals. If the yuan approaches the band limits or experiences extreme swings, the PBOC may step in. It will buy or sell yuan as needed to manage and slowly adjust its value. This method helps maintain a stable currency environment. Given the central bank’s ongoing efforts, we can expect further interventions. For months, the PBOC has set the daily midpoint stronger than market expectations, indicating its desire to prevent rapid depreciation of the currency. This strong “fixing bias” suggests that any increases in the USD/CNY exchange rate will be carefully managed. The economic pressures pushing for a weaker yuan persist, mainly due to the significant difference in interest rates between the US and China. US rates are much higher; for example, the US 10-year Treasury yield is about 4.4%, while China’s is close to 2.3%. This encourages capital to flow toward the dollar, making it unlikely for the Chinese currency to strengthen significantly.

Trading Strategies and Economic Data

This situation creates a good opportunity for range-trading strategies using derivatives. The PBOC’s actions limit the upside potential for USD/CNY, while weak economic fundamentals create a floor, keeping the exchange rate predictable. Selling volatility through options, such as short strangles or iron condors, could be beneficial, as these strategies profit when the currency stays within a specific price range. These strategies leverage the daily band and the central bank’s likely interventions at its edges. With the offshore yuan (CNH) trading around 7.25 against the dollar, the managed float offers some certainty about daily trading limits. We can also set up options that benefit from time decay when the asset’s price remains stable. However, it’s important to remember past events, like the unexpected devaluation in August 2015, which surprised the markets. While we are focusing on stability, we should use stop-losses to guard against sudden policy shifts. This history reminds us that the managed exchange rate system can change at the government’s discretion. In the coming weeks, we will closely monitor China’s monthly trade and inflation data for signs of stress that could lead to a policy change. A significant drop in exports or a shift toward deflation might push officials to allow a weaker currency to support the economy. These data releases will be key moments for reassessing our derivative positions. Create your live VT Markets account and start trading now.

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