The yuan fell sharply against the dollar in the spot and offshore forwards markets on Tuesday after a big jump in China's foreign exchange reserves indicated heavy flows of speculative money into the country.
Traders said the reserves data was bearish for the yuan because Chinese authorities could react to the flows by seeking to punish speculators - for example, by intervening to create a fresh pause in spot yuan's appreciation, or by engineering swings designed to increase risk for speculators.
The reserves surged by a monthly record of $74.46 billion in April to $1.75666 trillion, a source familiar with the data told Reuters late on Monday. The data has not been officially released. A range of factors, such as growing interest income from the reserves, probably caused the big increase. But traders and analysts said a major reason appeared to be large inflows of money speculating on further appreciation of the yuan.
"Overall, April's steep rise in forex reserves pointed to a trend: an increasing amount of 'hot money' is flowing into China to bet on yuan appreciation," said currency expert Shi Lei at Bank of China in Beijing.
The market, and parts of the Chinese government, are split on the best way of deterring such inflows - some analysts believe China may ultimately decide to boost the yuan dramatically in a short space of time, in an effort to make speculators feel they have little further room to profit from appreciation.
But many traders think rising inflows of hot money may prompt the central bank to clamp down on appreciation to punish speculators. It did this between early April and mid-May, holding the spot dollar/yuan rate steady to trigger panicked dumping of bullish yuan positions in the offshore forwards market.
In the wake of the news on the reserves, one-year offshore dollar/yuan non-deliverable forwards rose sharply to 6.5280 late on Tuesday from Monday's close of 6.4772. Their latest level implied yuan appreciation of 6.36 percent versus the dollar over the next 12 months from Tuesday's spot mid-point, down from 7.14 percent implied late on Monday. Implied appreciation plunged below 4 percent during speculators' panic in mid-May, after going as high as 14 percent in mid-March.