China's yuan slips, rally pauses after relaxation of FX outflow curbs

SHANGHAI: China's yuan eased slightly on Monday after rallying more than 1 percent against the dollar last week, with sentiment softening in the wake of a relaxation of controls on capital outflows.

Market participants said the latest lifting of restrictive measures on foreign exchange hedging and yuan deposits on China's mainland suggested that the authorities had started to worry about the rapidly appreciating yuan.

The People's Bank of China (PBOC) scrapped reserve requirements of 20 percent for financial institutions settling foreign exchange forward yuan positions while it lifted requirements for foreign banks to put aside reserves for offshore yuan deposits in China.

Prior to market opening, the PBOC raised its official yuan midpoint to 6.4997 per dollar - pushing it beyond the key psychological 6.5 level for the first time since May 2016.

Monday's midpoint was 35 pips or 0.05 percent firmer than the previous fix of 6.5032 set on Friday.

The central bank has guided the fixing higher for 11 straight sessions. But traders said Monday's midpoint came in much weaker than their models had suggested, which was the same situation last Friday. They suspected the weaker fixings were a result of the impact from the "counter-cyclical factor".

Economists at Goldman Sachs said in a note on Monday that the counter-cyclical factor had turned more reactive to the market appreciation pressures, potentially pointing to lower propensity to accommodate much more strength in the yuan.

"It is useful to continue tracking policy signals for the near-term CNY intention, including the counter-cyclical factor," they said.

The lower-than-expected fixing, together with the policy relaxation in capital controls, dragged the yuan down to weaker than the key 6.5 per dollar level.

The spot market opened at 6.5090 per dollar and was changing hands at 6.5040 at midday, 150 pips weaker than the previous late session close and 0.07 percent softer than the midpoint.

Traders said they had been waiting for official reaction to the yuan breaching 6.5 per dollar, the market's consensus as the bottom for dollar/yuan in the near term. And recent policy moves had triggered a change in market direction, they said.

Gao Qi, FX strategist at Scotiabank in Singapore, said the yuan would weaken against the dollar in a "knee-jerk response to hopes for potential hedging flows", expecting the Chinese currency to consolidate around 6.5 per dollar for now.

"We suspect the is unwilling to directly intervene in the FX market, to avoid PBOC scrutiny by the US, with the US Treasury semi-annual report due next month," Khoon Goh, head of Asia Research at ANZ said.

The Chinese currency has risen more than 2,000 pips since the beginning of August, an unusual run given it normally moves in a narrow range.

The authorities are beginning to worry about the rallying yuan as exporters come under strain, policy insiders told Reuters, a sign that the currency's gains might lose steam as Beijing prepares for a crucial Communist Party gathering in October.

Market watchers said despite the loosening of hedging and deposit rules, chances of major depreciation in the Chinese currency in the run-up to the Party Congress taking place next month is low.

"We believe that CNY appreciation will continue, but at a slower pace from now on," Iris Pang, economist at ING said in a note on Monday.