‘Counter-cyclical’ adjustment factor resumed to anchor Chinese currency
The People’s Bank of China (PBOC) announced on 24 August that China’s banks have resumed the counter-cyclical adjustment (CCA) factor in the Chinese Yuan (CNY) official midpoint this month. This is the second move of Chinese authorities after the adoption of a 20% reserve requirement of currency (FX) forward positions on 3 August. According to the PBOC, the moves are aimed at mitigating the Renminbi depreciation pressure arising from the procyclical sentiment caused by the strong US Dollar and ongoing trade frictions.
What is the “counter-cyclical” factor
The counter-cyclical adjustment (CCA) factor was first introduced in May 2017 as a third factor on top of the basket of trade-weighted currency indices and closing spot level at 4:30pm of the previous trading day when settling the official midpoint. The intention of this additional factor was to ward off the one-way bets on the Yuan and the subsequent capital outflows.
The first introduction of CCA in May 2017, when CNY was also weak at around 6.9 against the US Dollar, stemmed the depreciation trend and followed by sustained strengthening in the CNY against a basket of currencies. S&P China 500 index turned upward as well (as seen in Figure 1). This factor was suspended in January 2018 as the depreciation pressures dissipated.
Signal to support the Yuan
The announcement was seen as a signal from PBOC, which is not comfortable with further depreciation in the Yuan that could trigger capital outflows.
The Yuan hovered at a 2.5 week high against the US Dollar on 27 August, arresting the slump from the middle of June that has rattled global markets. S&P China 500 index followed the trend again as indicated in Figure 1.
Some market players go with the hypothesis of “7-3” threshold for the stability, that is, not breaching 7 (or around 6.9) for US Dollar vs. Yuan and FX reserves not falling below 3 trillion dollars for Chinese regulators.
Nevertheless, in the long term, the currency rate of world’s second largest economy will rest with the expected return and risk premium on the investment.
Figure 1: China’s Currency has indicated a positive relationship to behaviour of China’s equities
Source: Bloomberg, 31 December 2016 to 28 August 2018. You cannot invest directly within an Index.
Historical performance is not an indication of future performance and any investments may go down in value.
If investors believe that the PBOC action has the potential to have the desired impact, performance of China’s equities may very well become more interesting.