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USD CNY Mid Point – Does It Matter?
Just a quick question here from Horatio, wants to know what it means when the PBOC sets the U.S. dollar, Chinese yuan midpoint and why it matters for us as traders.
As always, thanks for the question, Horatio.
So looking at the midpoint setting it’s important to remember that the currency pay line for the U.S. dollar versus the Chinese yuan doesn’t have a free-floating exchange rate, like something like the Euro, U.S. dollar, or the pound, U.S. dollar, etc. And that is because the PBOC or the People’s Bank of China keeps a very strict control of the currency’s rates.
So every day the PBOC will basically set a midpoint for the yuan versus the U.S. dollar. And the bank will allow the currency to trade within a 2% range above and below that specific midpoint level. Now generally speaking, a much lower midpoint setting is considered as a more positive risk input and a much higher setting is considered as a more risk-negative input.
Now a key level to watch for the pair is the $7 level which did see lots of market reactions in terms of risk flows going back to 2019 when China basically deliberately weakened their currency to push the exchange rate above that $7 level for the first time since the global financial crisis and they did that to basically push back against the tariffs imposed on China by the U.S. Now the markets were interpreting the higher fixing above that $7 level as China’s way of trying to offset the impact of the U.S. tariffs, and to be fair to a large extent it did work.
However as you would expect, the Chinese government did deny that they devalued the currency on purpose in order to basically offset the impact from the tariffs, and rather insisted that it was due to just normal, fundamental reasons.
Now as a result of the weakening of the currency, the U.S. in 2009 did designate China as a currency manipulator, where that decision was of course reversed I think in early January this year, in a sign of good faith towards China, before the signing of the phase one trade deal.
Keep in mind that even though the midpoint fixing is an important point to watch it might be less and more important depending on U.S. and China trade relations. So if we have just a normal, during a normal risk of flight for example, and a massive global economic crisis, like we’re going through now.
One would expect the dollar to appreciate against the yuan as an emerging market currency as it does against most other emerging market currencies. So the context of why it’s rising is also an important consideration.
With tensions recently turning more negative with that negative rhetoric starting to pick back up against the two countries, due to the Coronavirus, that midpoint will be coming back into focus as the situation starts to intensify between the two countries.
So to sum it up, yes, the midpoint is important, but it might be more and less important depending on whether it’s a key focus point for the markets at that particular time.