China's yuan strengthened moderately on Thursday, tracking overnight gains in the euro and other non-dollar currencies, as traders say they expect the yuan's recent strong link to the euro to persist. Spot yuan closed at 6.3844 per dollar, 44 pips firmer than Wednesday, when it closed at a near 10-month low. The strengthening closely tracked the central bank's daily midpoint of 6.3381, which was 48 pips stronger than Wednesday's fix.
The yuan has closely tracked the euro in recent months. However, the euro gave back a chunk of its gains in early Asian trade on Thursday, and Chinese traders remain focused on the question of whether - if the euro continues its slide - China's central bank will allow the yuan to follow it down. In a shift away from what was conventional wisdom in early July, many traders now believe the central bank would tolerate further yuan weakness, if market forces push it that way.
Wednesday's setting of the mid-point was the weakest of the year and the first above the psychologically important 6.34 level, after the euro hit a two-year low the previous night. Traders say the central bank is likely to weaken the midpoint in order to shift it closer to where spot transactions are actually occurring. That would amount to a license for further depreciation.
The central bank has long used the dollar index as a reference for setting its daily midpoint, which is the base rate from which the yuan is allowed to rise or fall by one percent in a single day. The index tracks the greenback's value against a basket of currencies heavily weighted towards the euro.
But while the direction of the daily fixing is reliably in sync with the direction of non-dollar currencies, the central bank also tries to keep the yuan exchange rate broadly stable. That means that the magnitude of the daily fluctuations in the midpoint are often smaller than corresponding movements in the dollar index.