PBOC Playing With Fire; Informational Power of CNH Magnified Greatly

A debate is raging over whether the PBOC or the market is driving the yuan exchange rate. It's clear to me that the market wants to take the yuan lower and will take it much lower if allowed. The PBOC can claim the market is setting yuan's price in order to avoid being charged with manipulating the currency. What happens when they don't want it to fall anymore? Do they stop moving the fixing lower and show they are indeed in control? What happens if they stop devaluing CNY and the market decides to take CNH lower anyway?

The Informational Power of the Offshore Yuan Exchange Rate

Empirical results suggest that (i) developments in the offshore spot market could influence the onshore spot market in terms of both level and volatility during a period of offshore market dislocation, and (ii) the onshore market drives price movement offshore under normal market conditions, while developments in the offshore market could still affect the volatility of price movement in the onshore market.

Normal conditions, aka when models work. What happens in the periods when markets experience great volatility, change their pattern of behavior and even move to new equilibriums?

We can also find evidence that, despite wide-raging capital controls on flows between onshore and offshore markets, developments in the offshore market could influence onshore markets through volatility channels. Given that volatility in the offshore market has been higher than that in the onshore market, these findings imply that offshore market developments should be monitored carefully, as it could impact exchange rate stability on the mainland. In addition, during a period of offshore market dislocation, developments in the offshore market could influence the onshore spot market in terms of both level and volatility possibly because market participants believe that price development offshore better reflect global market conditions.

Update, Bloomberg: China Central Bank to Maintain ‘Normal’ Movement of Yuan Exchange Rate

China’s central bank said it will keep the yuan stable at a reasonable, equilibrium level as the currency fell for a third day after Tuesday’s devaluation.

The People’s Bank of China will promote a consistent onshore, offshore yuan exchange rate, it said in a statement delivered ahead of a rare press briefing Thursday.

The PBOC has applied a new methodology to determine the fixing: market makers who submit contributing prices have to consider the previous day’s close, foreign-exchange demand and supply, as well as changes in major currency rates.

The central bank said Wednesday there’s no economic basis for the yuan to fall continuously and that it would strive to improve market-based settings and keep the exchange rate “basically stable.” It intervened in the onshore spot market through agent banks on Wednesday to prevent the yuan from dropping too much, according to people familiar with matter.