China’s major state-owned banks have been observed exchanging yuan for U.S. dollars in the onshore swap market and selling those dollars in spot currency markets this week, according to two anonymous sources. The yuan has appreciated by 2% in the past week, reaching levels of around 7.13 to the dollar, its highest in nearly four months. The state banks have continued to sell dollars for yuan, a move that is typically seen as unusual as they would usually sell dollars when the yuan is under pressure to depreciate. The timing is interesting given the broad weakness of the dollar, with the dollar index retreating more than 3% in November due to signs of a peak in Federal Reserve monetary tightening. Some market participants speculate that the state banks are trying to accelerate the yuan’s gains and encourage exporters to convert more of their foreign exchange receipts into yuan. However, the Chinese currency is still down more than 3% against the dollar this year. As a result of the selling of dollars by state banks, the onshore spot yuan briefly reached 7.1296 per dollar, stronger than its daily official guidance for the first time in four months. The People’s Bank of China (PBOC) has also been lowering the dollar-yuan daily fixing rate this week, setting it at a 3-1/2-month low of 7.1406 per dollar on Tuesday. Analysts suggest that the PBOC’s actions may be a preparation for a policy rate cut, leveraging the favorable external environment to strengthen the Chinese yuan. While China’s economic recovery remains uneven and bumpy, with industrial output and retail sales surprising on the upside in October while manufacturing activity and consumer prices continued to fall, analysts argue that further monetary easing could put downward pressure on the Chinese currency due to the wide interest rate differential between China and other economies, particularly the United States. The PBOC has been injecting cash into the banking system through its medium-term lending facility (MLF) loans but has kept the rate on those loans unchanged. Analysts warn of potential volatility unless there are significant downside dollar moves or major positive sentiment events. They expect further policy easing, including PBOC rate and reserve requirement ratio (RRR) cuts. Despite these challenges, some analysts remain relatively optimistic about the yuan’s performance in the near future.
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