The inability of Chinese regulators to cool off a sustained yuan rally against the dollar has led some to predict Beijing will be forced to accelerate the pace of currency reform.
The spot yuan began hitting consecutive record highs against the dollar in October, peaking on October 31 when it posted its strongest close ever, at 6.2372 per dollar. Since then the People's Bank of China (PBOC) has moved to restrain further
appreciation by fixing the official exchange rate significantly lower than what the market expected. The traded exchange rate is allowed to diverge by 1 percent away from the official midpoint rate in either direction, so by setting an artificially weak midpoint, the PBOC has effectively leashed the yuan.
The PBOC is giving a strong signal that market forces aren't being given much weight at the moment, said Robert Minikin, forex strategist at Standard Chartered in Hong Kong.
For their part, the market forces have refused to respect the midpoint. Over the course of the past two weeks, the intra-day trading chart, which ordinarily resembles a heartbeat, began to resemble brain death: a series of flat lines interrupted by occasional spikes.
Such flattening represents consecutive trades repeatedly occurring at the edge of the trading band.
Until recently this was a rare occurrence, but last week the spot rate stayed more or less glued to the edge of the band, graphically illustrating the failure of central bank attempts to rein in bullish sentiment.
In response, local media - including state-run newspapers China Daily and the China Securities Journal - have run articles quoting analysts calling for the band to be widened for a second time before the end of the year.
Such a move is theoretically uncontroversial because Beijing has already said it plans to let the currency float freely.
I think they are going to widen the intra-day band again, because ultimately the goal is no band, said Chia Woon Khien, strategist at the Royal Bank of Scotland.
But she did not suggest a deadline for the move, and economists say that while more liberalisation is necessary, making a permanent adjustment to the current system in reaction to what most say is a short-term trend might destabilise the market, prompting more intervention, not less.
There is no urgency to widening the band, said Dariusz Kowalczyk, strategist at Credit Agricole CIB, arguing that the move should come as part of a wider liberalisation package that includes interest rate reforms and capital account opening. Traders also pointed out that the last time the PBOC widened the band, it did so when the rate was stable. Before another widening is implemented, they said, the bank will need to get the spot market back in line with the midpoint.
SOURCES OF STRENGTH
Many speculated that the charge of the yuan was originally provoked by Beijing to provide rhetorical ammunition to U.S. President Barack Obama's re-election bid, but now traders credit market-driven demand.
Companies accumulated too many dollars when the yuan depreciated over the first seven months of this year, while China's recovering exports and increasing trade surpluses in recent months have added to the dollar supply, said a trader at a major state-owned bank in Beijing.
A trader at a European bank in Shanghai concurred, adding that the glut could persist for the next few weeks.
The bank has easy options to hand. It can stick with the current strategy and use the midpoint to bluntly hold back the market, or it can intervene to vacuum up the dollar glut.
We think they'll intervene to bring the spot up (weaken) to the fix, said Minikin of Standard Chartered, adding that some anomalous trades over the past two weeks suggest the bank is already doing so.
Such a surge occurred in the last hour of trading on Friday, which some traders speculated was the beginning of a sustained attempt to force the spot market back in line.
However, the do-nothing option may also be viable. Few believe the yuan' s current strength is tenable.
There are short-term factors, maybe geopolitics, maybe optimism about the Chinese outlook, but that is only temporary, said Kowalczyk of Credit Agricole.
The balance of payments data doesn't support more appreciation. China needs to turn to policies supporting growth, and that will require a weaker yuan.