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China state banks seen swapping yuan for dollars in forwards mkt
China’s major state-owned banks were swapping yuan for dollars in the onshore forwards market, four currency dealers said on Friday, in trading operations suggesting that authorities were trying to manage the rapidly falling currency.
The state banks’ action was interpreted by the market as an effort to mop up dollars from the swap market, thus reducing the easy access to dollars for sales against the yuan.
…One-year dollar/yuan swap eased to a low of -2,180 points, the lowest level since Nov 2022, and effectively pushing one-year yuan to 6.82 per dollar.
Such swap operations are not new, and China’s state banks have used the same playbook of a combination of swaps and spot trade during the previous rounds of yuan depreciation. They have in the past also sold the dollars acquired via swaps in the spot market to slow the pace of the yuan’s decline.
However, the sources said they had not yet seen such spot trades this week.
Use of swaps has worked in the past to some degree. Not enough for the capital account to remain open, but enough to prevent a more serious depreciation out of step with other currencies. All the prior rounds came with limited dollar strength though. Continued strength in the dollar, not simply chop but a renewed advance, would turn swaps into a money losing proposition that fuels the next leg lower. Swaps and derivatives have blown up in the faces of other central banks. China’s avoided that fate thanks to prior dollar reserves, its size and control over markets, but ultimately because U.S. dollar strength was limited.
They picked a good spot for an intervention because the chart was getting a little vertical, but now lets see how far it retraces.
Long-term, I like to explain it this way: all through the 2000s, they were printing yuan at 8.28 for every dollar coming in. Leave aside credit growth, a dollar coming in would get 8 yuan in return. Credit growth didn’t slow after 2008, it exploded for several years. I sometimes post the reserves to M2 ratio, now below 8 percent, by saying in effect, “this number doesn’t matter until it does.” The nations of the Asian Crisis had much higher reserves before the 1997 collapse.
Forget 8:1, there are nearly 90 yuan in M2 for every $1 (valuation) of foreign reserves. To get back to 10 percent reserve coverage only through currency depreciation would take USDCNY to 8.77. Money supply will keep growing and FX reserves are going to be under pressure in this scenario. If reserves rise, it’s because USD is weakening and the global economy is expanding at a healthy clip. This situation is self-feeding in both directions.
There’s no market between the old peg and here. It’s almost as high as during the height of the pandemic panic, with only last year’s high as a final resistance. Technically speaking, a retrace of the entire artificial move (because it was managed) from USDCNY 8.28 down to 6 is open if and when a new high is made.
Note the prior highs:
November 2016, Trump elected. He eventually bails on a serious confrontation with China because the DJIA doesn’t like it.
October 2018, Powell pressing rate hikes. He bails on wringing QE out of the system.
August 2019. after effects from rate hikes and looming recession.
May 2020, pandemic fallout.
October 2022, global financial selloff makes first major tradable low.
All of those peaks aborted a breakout of the basing pattern. My firm belief is that one time, perhaps the next time if the stars align, there will be large enough economic and financial events to trigger a massive overnight depreciation in the yuan. The government did it in 1994, they did it in 2015, and they’ll do it again because it is the best policy for the government.