Spot traders benefit as China eases yuan

For players in China's tightly bound currency market, the authorities' loosening of the strings this month to allow wider yuan moves has boosted both opportunities for short-term profit, as volatility rises, and long-term risks, with yuan appreciation no longer a certainty. The People's Bank of China (PBOC) this month made yuan trading more of a two-way street than ever before, with relatively hefty day-to-day losses as well as gains, testing how the market will value the yuan as authorities gradually nudge their currency towards a free float and global status. China's leaders appear to be growing confident that, with the yuan up 30 per cent against the dollar since its landmark 2005 revaluation, and with the trade surplus shrinking and actually shifting into its biggest deficit in at least a decade in February, the currency is approaching fair value. This creates a whole new ball game for traders and investors long accustomed to a yuan market that only goes one way — up — and has done so in a gradual, orderly fashion. "There are clearly both business opportunities and risks if the yuan is trading in a wider range," said Wang Haoyu, economist at First Capital Securities in Shenzhen. "The rare trade deficit in February relieved pressure on the yuan to appreciate and presented a good opportunity to test the waters for reform." In the domestic market, one result of the new volatility has been dollar buying by banks and corporations for short-term speculation, never seen before when the dollar mainly moved lower against the yuan. More volatility also boosts potential profits, making it worthwhile to jump in for short-term speculators, especially for astute PBOC-watchers in a market where the central bank still exerts substantial influence. Offshore, some traders say short-term forwards of three months or less are now preferred for speculative plays, while contracts above six months are used increasingly for hedging purposes, as uncertainty mounts about the long-term trend. Most traders still believe the yuan will appreciate this year, despite a decline of 0.2 per cent so far since January 1, as exports are expected to rebound somewhat, but the full-year rise is likely to be much less than last year's 4.7 per cent. Moreover, as the spot yuan market in the mainland gains more freedom of movement, values are coming more closely into line with the overseas Hong Kong market, traders said. The spread between the two has narrowed to less than one-tenth what it was in January and barely one-thirtieth the divergence last September. These developments feed into China's aim to steadily deepen and develop the yuan market, and eventually make the yuan a freely traded international currency, although comments last week by Chinese Premier Wen Jiabao maintained the government's vague stance on when that might happen. The yuan volatility this month has been unprecedented in the 18-year history of the domestic currency market. In the first half of March, the PBOC's daily midpoint, the base rate indicating government intentions on currency values, saw a 0.7 per cent drop in the yuan against the dollar, the biggest 11-session loss since the domestic market's launch. Over the next seven sessions up to yesterday, the fixing's yuan value rose 0.8 per cent, the biggest seven-session gain in more than seven months. The dollar/yuan spot rate can rise or fall 0.5 per cent on any given day against the midpoint, which the PBOC says is set while taking market activity into account. A Reuters poll this month showed that analysts and economists believe China could double the daily trading band as soon as the second quarter..