Chinese yuan is down for the year, more losses coming

This may be the first annual decrease since the renminbi was devalued in 1994 and much more is coming. First the YTD chart:

I'm not going to post it, but the one month chart shows that the PBOC increased (depreciated the renminbi) the daily fixing more rapidly than the renminbi depreciated in the market. However, according to an article in the WSJ, this may be shifting: PBOC Yuan Fixing Hints At Shift
The Chinese central bank surprised some investors Friday by guiding its currency sharply higher, shrugging off the dollar's global strength and fresh signs of a weakening Chinese economy.

However, some observers say Beijing's seemingly counter-intuitive move reflects a major but quiet shift in the way it sets the yuan's value by deemphasizing the dollar's influence and focusing more on a weighted basket of currencies, an approach that is more in tune with Beijing's goal of fostering a more market-oriented exchange rate.

And based on such a methodology, the yuan's relative strength against the dollar Friday was partly the result of the overnight rise of the Japanese yen, a currency widely assumed to carry a heavy weighting in the yuan's reference basket, said traders, who reached similar conclusions via their own calculations.
My gut reaction is that the PBOC is trying to stop the renminbi from depreciating, That chart is starting to look worrisome given what's happening in Europe. The renminbi market price has fallen from 6.28 per U.S. dollar to nearly 6.37 per USD. If it falls through 6.40, it will be at it's lowest level since August 2011. There was a jump higher in July 2011, so there's not a major risk of trading down year-on-year, but if this trend keeps up, we could be looking at just such a situation by the end of July.

Now let's look at why it's very possible that the PBOC isn't trying to manipulate the market with the strengthening of the renminbi today, and that the real reason is currency diversification away from the U.S. dollar.
The PBOC has long been using the standard language of setting the yuan's value in reference to a basket of currencies, but some analysts said Beijing didn't put that into practice until the beginning of this year.

Although the PBOC has never disclosed the components of the basket, it's widely expected to consist of currencies of China's major trading partners, including the euro, yen and Asian units like the Korean won.

Dariusz Kowalczyk, an economist and strategist with Credit Agricole, said the main reason for the yuan's depreciation against the dollar last month was the PBOC's shift toward targeting the currency basket, instead of continuing to track the dollar.

"Until recently the PBOC has been largely tracking the U.S. dollar, trying to achieve appreciation against the U.S. currency that would be large enough to bring down imported inflation, rebalance growth away from exports and placate U.S. pressure - thus avoiding a trade war," he wrote in a recent research note.

But with inflation subsiding in China and exports weakening, policymakers were convinced that they need to provide support for exporters via a more competitive yuan, which would require the PBOC to change its methodology, he added.

In other words, using the broader dollar index to predict the daily dollar/yuan fixing may prove less and less reliable from now on, a challenge to investors lacking technology and expertise that can help create a mock currency basket for the yuan.
You don't need technical sophistication to know this bit: if the U.S. dollar has a strong rally, the renminbi will depreciate against the U.S. dollar. That will likely lead to a self-reinforcing trend whereby Chinese speculators buy dollars and exacerbate the trend.

One of my main reasons for predicting a depreciating Chinese yuan (and I've been wrong for about 2 years thus far) is that I expect a U.S. dollar bull market against foreign currencies, and the PBOC's switch to a currency basket means it will break with the U.S. dollar. Previously, China was adding euros during the first and second round of the Greek crisis, which structurally weakened the yuan (based on my expectation of euro depreciation). The above article shows that the PBOC hadn't followed its rhetoric and is only now relying on the currency basket, which could go a long way to explain the depreciation in May. The wildcard in the basket is the yen.

Speaking of which, from FT Alphaville: Yen weirdness du jour
“Although there might be differences (in views with the United States and European countries) from time to time, the Japanese government is determined to take an immediate response to volatility in the currency market,” he told a Euromoney forum.

“Monetary policy is important, but we shouldn’t exclude the possibility of taking our response in the market, which is intervention,” he said.

Nakao’s remarks were the most direct warning of intervention by Japanese policymaker since the yen began to creep up again on safe-haven demand amid worries about Europe’s deepening debt crisis, and came on the heels of similar comments by Finance Minister Jun Azumi earlier in the day.

“It is clear that the current one-sided currency moves do not reflect the economy’s fundamentals,” Azumi told a news conference after a cabinet meeting.

“We will need to take decisive action if excessive currency moves continue.”

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