SHANGHAI: China's yuan was little changed against the dollar on Tuesday as traders awaited the resumption of Sino-U.S. trade talks, while signs of seasonal liquidity tightening in Hong Kong drove offshore borrowing costs to a four-month high.
Prior to the market opening on Tuesday, the People's Bank of China (PBOC) set the midpoint rate at 6.7042 per dollar, 56 pips or 0.08 percent firmer than the previous fix of 6.7098.
In the spot market, onshore yuan opened at 6.7064 per dollar and was changing hands at 6.7098 at midday, only 8 pips weaker than the previous late session close.
Traders said some corporate clients were buying dollars, but such demand eased at around 6.71, leaving the spot rate confined to a narrow range of about 100 pips.
Some market participants also pointed out that volatility in Chinese stocks was creating a spillover effect on the yuan amid recent capital flows through stock connect.
Senior officials have recently talked about financial sector opening, but Iris Pang, economist for Greater China at ING, said a further opening of outflow channels is unlikely this year.
"We may see more capital inflows into China via passive funds that follow the MSCI and Bloomberg bond indices but we doubt there will be a further opening up of capital outflows channels, as this would create extra risk to the weakening economy," Pang said in a note.
"So the yuan will likely continue to follow the dollar index but won't be a truly free floating currency until China really opens up its capital account."
She believes the yuan is more likely to strengthen this year and maintains her forecast that it will trade at 6.75 by year-end.
Separately, Hong Kong's overnight yuan borrowing rate was fixed at 2.97578 percent on Tuesday, the highest level since Nov. 23 and about 52 basis points up from the previous fix of 2.45592 percent.
The CNH Hong Kong Interbank Offered Rate benchmark (CNH Hibor) is set by the city's Treasury Markets Association (TMA).
A rise in the overnight borrowing costs means signs of liquidity tightness, which could raise the cost of shorting the yuan in offshore markets. The offshore yuan was little changed in morning trade, however.
Ken Cheung, senior Asian FX strategist at Mizuho Bank in Hong Kong said the surge in the borrowing cost on Tuesday was mainly triggered by month-end and quarter-end seasonal cash demand in the financial hub.
Chinese markets remain focused on the progress of U.S.-China trade talks as the two sides' tit-for-tat tariffs continue to weigh on business activity on both sides of the Pacific. United States Trade Representative Robert Lighthizer and Treasury Secretary Steven Mnuchin will travel to Beijing for negotiations scheduled to start on March 28.
"No one knows what will happen ... The yuan does not show a clear direction at the moment. For clients, they are unwilling to hedge when the yuan is directionless due to the cost of hedging. The market is at an equilibrium level and awaits the outcome of the trade talks," Mizuho's Cheung said.
The global dollar index fell to 96.51 at midday, from the previous close of 96.566. As of midday, the offshore yuan was trading at 6.714 per dollar.
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