China recently announced that it will double the permissible band within which the Chinese yuan (CNY) can fluctuate from the daily fixing rate.

The timing of this announcement was a surprise and it was bold. But in the overall scheme of things, it is perfectly in sync with China’s New Year’s resolution to further deregulate its semi-fixed exchange rate system this year, or more directly, fulfill its ambitions of making the CNY an internationally accepted currency.

There are several implications of this move:

  • First, there will clearly be larger fluctuations and more volatility for the CNY going forward. Ever since the People’s Bank of China (PBoC) hinted that the CNY may deregulate further, the currency has seen 12 times more volatility. Investors should realize that they have to start thinking about managing any CNY exposure they have.
  • Second, the CNY will no longer be a one-way bet. It was well-known that the CNY was undervalued and so there was only a one-sided CNY appreciation expectation in the market. The new, two-way flows will allow a more balanced market expectation and hopefully an efficient allocation of capital.
  • Finally, PBoC won’t need to intervene in the market as aggressively, which means that it will buy less U.S. dollars (USD), EUROs (EUR) or U.S. Treasuries. The more than $3 trillion in foreign exchange reserves held by China is said to be primarily in USD but somewhat diversified into the EUR.

My View: Corporations that have exposures to China may start planning to hedge their FX risks. City National Bank was one of the first banks in the U.S. to offer offshore Chinese yuan (CNH) payments, deposits, and options to our clients. We have dedicated China specialists. We look forward to helping you find the right solutions for your firm.

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