The yuan rose against the dollar on Tuesday after the People's Bank of China set its mid-point near a record high, a signal the government's drive to contain inflation may have triggered a new leg of appreciation.
The yuan is only a whisker away from its highest level since its landmark revaluation in July 2005 and is likely to breach that level this week after the PBOC surprised the market by raising official interest rates on Christmas Day in a sign of Beijing's determination to nip high inflation in the bud.
Offshore yuan forwards, the main means by which foreign investors bet on the Chinese currency, may in coming days increasingly reflect greater appreciation over the next year. Spot yuan closed at 6.6248 per dollar on Tuesday, up from Monday's close of 6.6308 and only 75 pips away from its post-revaluation high of 6.6173 hit on November 11.
The PBOC fixed the day's mid-point, from which the yuan can rise or fall 0.5 percent in a given day, at 6.6252, up from Monday's 6.6305 and within arm's reach of its record high of 6.6239 set on November 12. Traders said the yuan might not be able to effectively breach the psychologically important level of 6.60 to the dollar this year, with only four trading days left, but its gain could quicken in January ahead of the Sino-US summit in Washington around January 19.
One-year non-deliverable dollar/yuan forwards (NDFs) were bid at 6.4800 in thin holiday trade, up from Monday's close of 6.4720. Their implied yuan appreciation in a year's time dropped to around 2 percent from 2.37 percent. Shorter-term three-month NDFs rose to 6.5910 from Monday's close of 6.5880, implying yuan appreciation in three months' time of 0.52 percent, down from 0.56 percent.
The spread of 1-month NDFs over 1-year NDFs has narrowed since November to 0.1355 from 0.1990 on profit-taking in the more liquid 1-year tenors. A sustained period of stronger mid-point fixings though, similar to September-October of this year, could cause that spread to widen again, as investors dump the 1-year NDFs.