Tuesday, July 16, 2013

Yuan daily volatility hits record levels

Over the past few weeks, the daily volatility in the dollar/yuan exchange rate hit record levels.

Yuan FX volatility

China's authorities have tight controls over the yuan's longer term level but they have a more "relaxed" FX exchange rate policy over shorter periods. While the specific transactions causing this volatility are not known, a couple of trends seem to be contributing to larger fluctuations in the exchange rate.

1. Exporters who submitted fake tickets for sold inventory to allow them to take speculative currency positions (particularly with respect to the HK dollar, which is linked to USD) have been precluded from continuing this activity (see post). Some had to unwind positions in the spot market.

2.  Borrowing US (or HK) dollars in order to short them now requires additional collateral, which makes bets against the dollar more expensive. That increased collateral rule went into effect a couple of months ago, but some of these forward trades are just now maturing.

3. The forward and options markets have seen a spike in trading volumes, as investors take bets on China's economic trajectory.
Bloomberg: - Volume in options on the dollar-Chinese-yuan exchange rate amounted to $3.83 billion, the largest share of trades at 19 percent. ... Dollar-yuan options trading was 101 percent more than the average for the past five Tuesdays at a similar time in the day, according to Bloomberg analysis. 
And that derivatives activity is also adding to the volatility in the spot market.

Recent short-term fluctuation in USD/CNY (source: Investing.com)

The currency has weakened a bit recently (see story) as well. At least some of this volatility and currency weakness underscores the rising uncertainty with respect to not only the direction of the economy, but also to the PBoC's policy and regulatory framework going forward. Furthermore, this is an indicator of increased concerns about China's wealth management products (see story) and the risks associated with potentially unwinding this massive credit market.

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