Chinese Yuan weakening adds to regional depreciation pressure

China shocked the world by changing the CNY fixing mechanism unexpectedly, and the entire market tumbled, especially EMs. CNY/CNH itselfrecorded the steepest drop in both fixing and spot since 1994.

The key improvement in the new mechanism was to incorporate the previous day's spot close as an important variable in deciding the next day's CNY fixing price. The other two variables to be considered by market makers in submitting quotes to form the basis of USD/CNY fixing calculation are demand-supply conditions and changes in exchange rates of major currencies.

The CNY fixing is supposed to serve as a benchmark for the market spot. However, before the change, fixing and spot largely deviated from each other, which is neither an indication of fixing being an appropriate benchmark nor good for the CNY joining the SDR basket. Furthermore, poor July economic data exacerbated expectations of more weakening as it highlighted the need for policy support for exports and output.

From 10 to 18 August, the CNY fixing was adjusted from 6.1162 to 6.3966, up by more than 2800 pips representing 4.6% depreciation against the greenback, and in the meantime the CNY and CNH spot depreciated by 2.9% and 3.6%, respectively. PBoC also stated in its briefing on 13 August that high volatility and depreciation is expected in the short term.

However, it is prepared to intervene to prevent either from persisting in the longer run. The main goal is modest currency depreciation and convergence of spot and fixing. In fact, the PBoC has reportedly heavily intervened in the onshore spot market since last Wednesday. 

"Looking forward, in the near term, we believe CNY spot will fluctuate at around the 6.40 level while CNH at around 6.45. In the medium term, we see CNY and CNH gradually converging and weakening toward 6.50 by year-end", says Credit Agricole.