PBOC Announces CNY Band-Widening

By Win Thin

The PBOC announced a band-widening for USD/CNY over the weekend, doubling the allowable band around the fix rate to +/- 2%. Off of Friday’s fix, the new band is 6.01-6.26 vs. 6.07-6.20 previously. The USD/CNY band was last widened in April 2012 from +/- 0.5%, and before that in May 2007 from +/- 0.3%.

We are surprised only by the timing, as we thought current market conditions were too unfavorable for a policy move such as this. Given that the widening comes at a time of CNY weakness, we think the implicit message is that the authorities are comfortable with further currency weakness, as well as greater two-way movements in the exchange rate.

In the current environment, the risk is that spot CNY moves towards the weak end of the new band. We have identified the 6.15 area (and above) as key in terms of realized losses for on-shore wealth management products. Spot CNY could easily trade above this area and remain within the new trading band. As such, we warn markets to expect more negative headline risk out of China in the coming weeks.

The economic data from China has already been softening, but concerns about the financial sector are likely to rise with this move. Market sentiment was already jittery ahead of the weekend, and we expect the PBOC move to feed into further risk off trading to start off this week.

That said, we do not think there are systemic risks building. The move by the PBOC should be seen as a calculated one, knowing full well that some wealth management products are likely to come under stress. Policymakers in China rarely panic, and so this should be seen as a carefully made choice weighing potential costs and benefits.

While the move is in keeping with China’s pledge to allow for a greater market role in the exchange rate, the daily fixing still gives the PBOC a large role in determining FX movements. The process towards a market determined exchange rate and full convertibility remains a long, slow one. This move is just the latest of many, with more small and careful steps likely to be seen in the coming months and years.