One-year offshore non-deliverable forwards (NDFs) rose to a nearly two-month high on Friday, implying less yuan appreciation in a year's time, as arbitrage between the NDFs and China's onshore forwards is narrowing the spread in the two markets.
One-year dollar/yuan volatilities stayed at a more than two-month high on Friday, implying that the market has been increasingly hedging against future risk of fluctuations in the yuan's exchange rate against the dollar.
Spot yuan fell slightly after the Chinese central bank set a weaker mid-point, or its reference rate, despite the dollar's fall on global markets overnight, reflecting Beijing's intention to keep the yuan stable for now. "A wide spread between the NDFs and onshore forwards has pushed both Chinese and foreign banks to be more active in arbitraging between the two markets since late May," said a senior dealer at a major Chinese commercial bank in Shenzhen.
"In addition, increasing fluctuations of the US dollar on global markets also cast uncertainty on the yuan/dollar rate in coming months, making the banks correct their high expectations of yuan appreciation and pushing up yuan/dollar volatilities."
Offshore one-year dollar/yuan NDFs rose to an intraday high of 6.7630 bid on Friday, its highest level since April 29 and up from Thursday's close of 6.7500. Twelve-month yuan appreciation implied in the benchmark NDFs, which moves inversely with the NDFs' levels, fell to 1.05 percent from the day's Chinese central bank mid-point, the least yuan appreciation the NDFs implied since April 28 and down from 1.22 percent implied on Thursday.
The NDFs began to imply strong yuan appreciation of more than 2.0 percent in a year's time in late May, propelled by a steep fall in the US dollar index at that time. Meanwhile, onshore forwards, which are more affected by China's currency policy, were forecasting a nearly unchanged yuan exchange rate against the dollar in a year's time.
As a result, during the period from late May to the end of last week, the spread between the two markets had remained consistently more than 1,000 pips - a comfortable zone for banks to profit on arbitrage. With more banks pursuing the business, the NDFs were pushed back sharply higher from a nine-month low of 6.6650 bid touched on June 1, and their spread against onshore forwards narrowed to 806 pips on Friday.
One-year dollar/yuan volatilities were mostly quoted at 6.70 percent bid, unchanged from Thursday and staying at its highest level since mid-April, caught between an increasingly volatile dollar and a stable yuan.
The Chinese central bank has virtually pegged the yuan to the dollar since late May within a narrow range of less than 100 pips, with the strong end at 6.8300 yuan per dollar, as China appears to prefer to wait for clearer signs of its own and global economic prospects before adjusting its currency policy. It fixed its daily yuan/dollar mid-point at 6.8338 on Friday, down from Thursday's 6.8321. Spot yuan closed at 6.8362 against the dollar, down from Thursday's close of 6.8347.