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New Yuan Index: Is the PBoC hinting at further currency depreciation?

Discussion in 'Fundamental Analysis' started by FXStreet_Team, Dec 22, 2015.

  1. FXStreet_Team

    FXStreet_Team Well-Known Member Trader

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    FXStreet (Mumbai) - The China Foreign Exchange Trade System (CFETS) on 11th December introduced a new exchange rate index. The new index will ensure that the value of yuan is seen against a basket of 13 other trade-weighted currencies. Yuan’s moves against a basket of currencies belonging to its trading partners will be measured by the index. An article on the central bank site however clarified that referencing the yuan to several currencies doesn’t mean the exchange rate is pegged to that basket.

    Objective: shift focus away from yuan’s volatile movement against the dollar?

    Economists believe the PBOC's latest step is probably aimed at drawing attention to the yuan's strong performance against a wider set of currencies as opposed to its more volatile moves against the dollar. It is worth noting here that the yuan has fallen 3.9 per cent against the dollar in 2015 but has advanced against 12 of 16 major currencies tracked by Bloomberg.

    Bank of America Merrill Lynch aptly explained the situation mentioning "Shifting the market's yuan focus to a basket of currencies is an attempt to manage market expectations away from yuan weakness against the dollar”.

    Goldman Sachs is of the opinion that this move will enable authorities to offset value of dollar without causing a “major increase in policy uncertainty or expectations of a sharp one-off devaluation ahead.”

    Introduced before the Fed rate hike decision, the index is an essential tool that The PBOC plans to use to ease depreciation concerns and in the process prepare the market for further yuan weakness. Societe Generale SA strategists Jason Daw and Frances Cheung believe that the initiation of the index before the Fed rate hike was an attempt on part of the PBoC to “cut the link with a strong dollar”, which China guessed would be the outcome of the rate hike. The objective of the central bank is to lower the yuan without causing any upheaval in the market. With the initiation of this index, the PBoC is likely making way for further gradual and controlled renminbi depreciation.

    a more transparent float regime


    Some economists feel that the new index will mark the beginning of a more transparent float regime. According to a recent report by HSBC, the new index can be expected to move China closer to a "clean floating" foreign-exchange regime”. The initiative to start the new index has been taken at a time when China is seen preparing to challenge America's dominance of international finance. The first step in that direction has already been taken as the IMF on 30th November decided to include the yuan in the SDR basket.

    How will the index impact the yuan?


    Goldman Sachs Group Inc., DBS Bank Ltd. and Daiwa Capital Markets all expect the yuan to fall further. This decision to introduce a new index can be treated as an official confirmation that the currency is no longer pegged to the dollar. Daiwa Capital forecast yuan to decline 14 per cent decline to 7.50 versus the U.S. currency by end-2016. Goldman also sees a drop to 6.60.
    It is also feared that the yuan weakness will extend to other Asian currencies. Bank of America feels the performance of Japanese yen, Korean won, Taiwan dollar and Malaysian ringgit must be watched closely from here on.
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