2018-08-03

The Red Line: China Defends Yuan at 6.90

The PBoC changed margin requirements of FX traders today, hiking from 0 to 20 percent. There's no fundamental reason for the shift except that the bank has begun its defense of the currency. Although USDCNY 7.0 is widely expected to arrive in the next 5 months, it is an unknown how the wider market will respond. Depreciation pressures haven't intensified yet, but at some point it will begin and even ordinary Chinese will start thinking about moving money overseas, trying to buy some dollar deposits, buying gold, etc.

Changing margin requirements is a low cost move that won't cost any reserve, but it does now heighten the game as the central bank reveals where it will begin defending. Up until now there's been a widespread assumption, mostly from late arrivals, that the decline in the yuan was part of the trade war. Instead, it was almost entirely a result of the rising dollar. Trump's escalation to 25 percent tariffs did ignite some yuan-specific selling as the yuan and Chinese stock market have led the emerging market complex lower in the past few days. Still, yuan depreciation to this point is well within the expected range given U.S. dollar appreciation.

The PBoC's move wasn't cost free though. Until now it wasn't clear if the Chinese wanted the depreciation or not. Now they've shown their hand. USDCNY 6.90 is where the battle begins. If China will spend reserves to defend the yuan, it is above USDCNY 6.90. The game is afoot.

ZH: China Nukes Yuan Shorts: PBOC Raises FX Fwd Reserve Requirement To 20%

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