PBoC’s interventions to depreciate CNY seems to be successful as the Chinese central bank (PBoC) continues to weaken its currency via the fixing, the fixing rates are generally in line with what the fixing model suggests so far. USDCNY fixing rates continue to spike higher, which has triggered speculation that further CNY depreciation is looming on the horizon.

China’s July activity data is likely to have been impacted by the severe flood situation in the country. The nation’s industrial production is likely to have slowed sharply to about 0.1 pct on a sequential basis in July from June’s 0.5 pct. This would be the most decelerated pace since the seasonally-adjusted data in 2011.

Today marks the one-year anniversary of so-called “one-off devaluation of CNY”. In the past year, CNY depreciated by 7.4% against USD and weakened by more than 10% versus a basket of currencies. There have emerged signs that CNY has stabilized somewhat recently as capital outflows have eased and the market has adjusted the expectations on Fed’s rate hike process. Of course, the strict capital control measures have been working, which implies that China’s capital account liberalization is still far away from us.

The fact that CNY will be officially included into SDR basket from 1 October 2016 is no reason for optimism in this sense.

On the contrary, for the PBoC it is far more important to narrow the CNY-CNH spread. A sizable spread between CNY and CNH will bring about some operational issues if CNY joins the SDR basket, according to IMF’s assessment report.

There is a piece of news this morning that China will allow local banks to trade CNH very soon – in other words, Chinese commercial banks will take the responsibility to narrow the CNY-CNH spread.

Hedging Tips:

In the meantime, CNY has weakened somewhat against the basket of currencies, overall, it’s a 7.4% USD/CNY rise in a year, an 8.4% rise in EUR/CNY and a 23% fall in CNY/JPY. Further depreciation is likely in the months to come, hence, it is recommended to buy either 6M USDCNY forwards of January expiries or deploy debit call spreads eyeing on above mentioned forecasts of USDCNY.

Those who are suspecting the following USD softness due to the US Fed has changed the stance for hiking funds rate and to defer until beginning 2017, we understand that there is little-implied volatility in the OTM strikes which is why it is advisable to choose longs in 6M (1.5%) ITM strikes in the debit call spreads, while shorting 3M (1.5%) OTM strikes.