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 That's bad news for speculators still holding onto bullish yuan
positions. And for the People's Bank of China (PBOC), the risk is it
has unleashed bearish forces it may not be able to rein in, souring
enthusiasm for the yuan and complicating the push to increase the
international adoption of the currency.
"The market had expected the yuan's weakness to last no more than a
few weeks, but the PBOC has now sent clear signals that it is the
central bank, not the market, that will decide when the yuan's
weakness will end," said a trader at a European bank in Shanghai.
"With the PBOC giving no signal that it intends to do so, corporates
have become alarmed, and many are now building dollar positions to
hedge."
Since the central bank started aggressively pushing the currency
lower in February, to shake the market out the view the yuan was a
one-way bet, it has fallen more than 3 percent and more than unwound
its gains of 2013.
On Wednesday, it touched an 18-month low of 6.2676 per dollar.
Markets were closed for holidays on Thursday and Friday.
For its part, the PBOC has continued to set the daily midpoint rate
near seven-month lows, which traders say signals it is still happy
with current levels.
Initially, traders said the PBOC had to play hard ball to convince
them it was serious -- especially since its last attempt to pull
back the yuan in late 2012 was widely considered a failure.
Instead of relying solely on using the midpoint to guide the market,
traders said the PBOC also ordered major state-owned banks to buy
dollars and dump yuan. Facing that much firepower, smaller market
players had no choice but to follow.
But now dealers say such intervention is no longer necessary;
"animal spirits" have taken hold and, in the context of wider
economic malaise, given the trend a momentum of its own.
And following the doubling of the yuan's trading band in March to 2
percent either side of the midpoint, the market has a much bigger
say over the direction of intra-day trade.
LESSONS FROM 2012
For investors clinging to bullish derivative bets, and for
foreigners who moved funds into Chinese equities and bonds in recent
months, signs that market sentiment is souring on the yuan are
unwelcome.
"Short-term flows do tend to exhibit herd behavior, which could
generate unstable capital-flow dynamics in the short run," said
Enswar Prasad, economist at Cornell University and former head of
the International Monetary Fund's China division.
"Further depreciation of the renminbi (yuan) could feed on itself as
domestic capital could start leaving China in search of higher
returns and for diversification purposes."
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The last episode of sustained yuan weakness was more moderate, with
the currency losing about 1.6 percent over five months in the first
half of 2012.
Even that had a noticeable negative impact on offshore sentiment
toward the yuan, a setback for Beijing's project to make its
currency a rival to the dollar.
Perhaps with that in mind, the PBOC has moved to further ease
cross-border flows for major multinationals, another step in opening
up its capital account.
In addition, the Ministry of Finance has moved to support the
offshore yuan market in Hong Kong by announcing it will issue a
record 28 billion yuan of offshore dim sum bonds this year.
WEAK YUAN, BIG LOSSES
Morgan Stanley said in March it expected speculators could incur
losses of up to $200 million per month if the yuan fell below 6.20
yuan per dollar. It weakened past there on March 19 and has been
there, for the most part, ever since.
Prasad does not believe Beijing is running a major risk by leaving
the market down for a little while longer, and said the easing of
rules on cross-border flows was a sign of confidence that panic
outflows would not ensue.
And Goldman Sachs Global Macro Research said in a report published
on April 25 that long-term fundamental inflows have so far been
largely unfazed by the yuan's decline.
But with the economy growing at its slowest annual pace in 18 months
in the first quarter and economists saying it could slow further,
there is little to suggest a turnaround in yuan sentiment.
"With credit efficiency declining and funding costs up, the
re-acceleration in credit required to revive growth will likely need
to be even larger this year," BNP Paribas chief Asia economist
Richard Iley said in a research note.
"More yuan weakness is, of course, the other option."
(Editing by John Mair)
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