"Policy in China is proving to be more tolerant of weaker growth, and more resistant to abandoning its efforts to de-lever the pockets of debt." We still think that weakening currency is the logical result of this, and the authorities don't plan to draw a line in the sand.

China Escalates Yuan Defense to Stop Selloff Spiraling.

China is boosting its Yuan defense, raising funding fees in the offshore market to squeeze short positions and establishing a new record with its stronger-than-expected Yuan reference rate.

According to analysts, the actions are intended to halt the rate of Yuan depreciation rather than create a lasting rebound. Forecasters at JPMorgan Chase & Co., Nomura Holdings Inc., and UBS Wealth Management all expect the currency to fall further this year. The offshore Yuan reversed previous advances to fall back towards its 2023 bottom recorded last week.

Last week, the People's Bank of China set its daily exchange rate for the currency at 7.1992 to the dollar, against an average estimate of 7.3103 in a survey. Since the polls began in 2018, that was the biggest gap.

The Yuan one-month forward points, a gauge of the cost to borrow the currency relative to the dollar, had risen the most in offshore trading since 2017 the day before the fixing's record-breaking positive bias. According to traders, funding costs have increased recently as local banks have held back on supplying more of the currency to the exchange market. That might increase the cost of speculators betting against the Yuan.

In yet another indicator of a liquidity crunch, Hong Kong's offshore Yuan interbank rates rose to their highest level since 2018.

For months, the Yuan has been under pressure as China's economy struggles, and PBOC interest-rate cuts have widened the yield disparity with the US. While the central bank is loosening monetary policy, it is also attempting to stem the Yuan’s depreciation through stronger-than-expected fixes, dollar sales by state institutions, and other measures such as changing capital-flow laws.

Since any disorderly depreciation might start a spiraling downward spiral of excessive falls and capital outflows, Chinese policymakers have been acutely aware of any speculator-driven violent Yuan movements for years. The central bank stated in its most recent monetary policy report, which was published last week, that it will fiercely prevent "over-adjustment" in the Yuan with a plentiful supply of policy tools to regulate the currency.

According to analysts at Citigroup Inc. Philip Yin and Gaurav Garg, a CNH funding crunch "could be a tactical tool and a signaling device, but unlikely the go-to tool in isolation." Overall, the combination of the rate decrease and more FX measures suggests that fundamentally driven Yuan depreciation is permitted but the pace is controlled.

In excess of the 25 billion Yuan in securities due this month, the PBOC sold 35 billion Yuan ($4.8 billion) in bills on Tuesday in Hong Kong. Data gathered by Bloomberg show that was the first occasion in the past two years that the central bank has skipped a flat rollover. 20 billion Yuan in three-month notes were part of the offering, and they were sold at a yield of 3.2%, the highest since 2018.

On Monday, the 12-month tenor reached a three-month high. Forward points have risen after certain tenors fell to record lows in recent months, pushed down by the US-China yield difference. US two-year Treasuries yield around 290 basis points higher than Chinese government bonds of comparable duration, the largest difference since 2006.

According to strategists at Deutsche Bank AG led by Perry Kojodjojo, "Policy in China is proving to be more tolerant of weaker growth, and more resistant to abandoning its efforts to de-lever the pockets of debt." We still think that weakening currency is the logical result of this, and the authorities don't plan to draw a line in the sand.