Yuan weakens despite tighter liquidity offshore

SHANGHAI: China's yuan finished domestic trade lower on Tuesday, as broad strength in the U.S. dollar eclipsed the stronger yuan midpoint set by the central bank and signs of tight liquidity for offshore yuan.

In the onshore spot market, the yuan ended at 6.8290, 55 pips weaker than the previous late night close, and weaker than the open at 6.8227 per dollar.

Prior to the open, the People's Bank of China (PBOC) set the daily midpoint rate at 6.8183 per dollar, 164 pips or 0.24 percent firmer than the previous fix of 6.8347.

The dollar advanced across the board on Tuesday afternoon, as concerns about a likely escalation in trade conflict between the United States and China prompted investors to buy the greenback.

The public comment period on a U.S. proposal for new tariffs on Chinese goods is set to end on Thursday, after which U.S. President Donald Trump can follow through on plans to impose tariffs on $200 billion more of Chinese imports, though it is unclear how quickly that will happen.

"This is going to increase downside risks to the global economy, in terms of global growth. It is going to increase downside risks on China's economy," Craig Chan, global head of emerging markets strategy at Nomura told reporters in Shanghai.

"We believe this will increase policy stimulus to come up from China and increase currency flexibility as well. RMB, if needed, will be allowed to depreciate more on the back of U.S.-led trade protectionism."

Chan added that he expects the yuan to face more depreciation pressure in the near term and forecast the yuan to trade below the key 7 per dollar level by the year-end.

Chinese state-owned banks have swapped dollars for yuan in tenors ranging from a month to a year in the offshore forwards market in recent days, traders said on Tuesday, providing some support for the yuan as markets braced for a potential major escalation in the U.S.-China tariff war.

Such operations by big banks effectively raised the cost of shorting the Chinese currency and support the offshore yuan .

"The tighter CNH liquidity condition could be a warning on CNH bears: there could be a CNH liquidity squeeze if market participants attempted to short sell CNH on the speculation of U.S. tariff implementation," said Ken Cheung, senior Asian FX strategist at Mizuho Bank in Hong Kong.

Among the tools for stabilising the yuan, the offshore liquidity squeeze "should be a preferred option" after the PBOC resumed using a "counter-cyclical" factor in onshore midpoint setting as the central bank "would not spend a penny of its FX reserves," he said.

The offshore yuan was trading at 6.8504 per dollar as of 0830 GMT.