China’s central bank is finding that some of the most stubborn yuan sceptics are lurking in its back yard.

A tug of war between the People’s Bank of China and investors in the country’s domestic foreign-exchange market has played out almost daily in recent months, with the yuan consistently closing weaker than the level set by the central bank.

While the central bank’s support has helped the yuan gain 2.2 per cent against the US dollar this year, after three years of declines, Chinese investors have been focusing in recent weeks on factors that could drag the currency lower in the coming months, traders say.

Many investors expect the Chinese economy to slow in the second half, as authorities try to cool the country’s reliance on debt-­fuelled growth. That could force Beijing to rely on a cheaper yuan to turbocharge China’s sizeable export sector.

The Federal Reserve, meanwhile, is predicting further US ­interest-rate increases, which should boost the US dollar against the yuan.

And while China has clamped down on capital outflows in recent months, there is still demand for foreign assets from Chinese people as they seek to diversify their wealth. That could exert downward pressure on the yuan.

Conversely, the central bank’s chief objective is yuan stability as it seeks to keep the economy on an even keel.

The tension is showing up in how the yuan trades inside China.

China’s central bank sets the yuan’s value against the US dollar 15 minutes before trading starts at 9.30am each day. The currency is then allowed to trade 2 per cent above and below that so-called fix.

In recent months, the yuan has usually started weakening from the fix once trading starts. On May 18, it closed 0.4 per cent lower: a bigger one-day drop has happened just 10 times since the PBOC devalued the yuan in ­August 2015.

The downward pressure persisted until the central bank stepped in later that month, market participants say, directing state-owned banks to buy yuan and sell US dollars. It also changed the way it calculates the fix by adding a “countercyclical” component that gives it more control over the currency.

The PBOC didn’t respond to a request for comment.

The central bank’s apparent intervention didn’t shift Chinese investors’ expectations for long. The yuan closed at a weaker level versus the central bank’s fix for most of June. That has continued this month, though to a smaller degree, after another bout of suspected intervention by the central bank late last month.

In all, the yuan has closed weaker than the fix on 25 of the past 29 trading days. It weakened 0.1 per cent from the central bank’s fix on Monday and 0.02 per cent on Tuesday.

“Once the PBOC stops intervening, there’s actually great pressure for the yuan to fall because the weak outlook of our economy and the financial risk we’ve accumulated are still hanging over our heads,” said a Shanghai-based senior currency trader at a bank.

Chinese exporters, major players in the domestic currency market, appear unconvinced that the yuan will steady.

Deposits of foreign currencies at Chinese banks hit a record of $US779 billion ($1 billion) in May, according to data from Wind Info going back to 2002, suggesting that many big companies are parking their greenbacks at banks rather than swapping them into yuan.

The PBOC’s main struggle in the past has been with overseas investors betting against the yuan in offshore markets, where the currency trades more freely. On several occasions in the past 18 months, the PBOC has squeezed short-term borrowing costs for the yuan in Hong Kong, making it expensive for investors to bet against the Chinese currency.

“We know when there’s a major sell-off in renminbi (yuan), the PBOC will intervene,” said Edmund Goh, Asian fixed-income investment manager at Aberdeen Asset Management in Singapore.

“I would not want to bet against the PBOC.”

By SAUMYA VAISHAMPAYAN
The Wall Street Journal

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