USD/CNH: Encouraging signs from China’s economy may spark deeper reversal

The Chinese yuan looks set for its largest gain against the US dollar since March, propelled higher by better-than-expected lending data and a pledge from the People’s Bank of China to guard against one-sided FX moves, demonstrated by the bank fixing the onshore yuan at the strongest level on record relative to expectations on Monday.

Triple-whammy of factors spark USD/CNH reversal

Having come close to hitting a record low against the USD on Friday, the dollar has weakened by close to 1% today, sending USD/CNH sliding below 7.3000 at one stage.

Comments from Bank of Japan Governor Kazuo Ueda over the weekend suggesting policy rates may increase next year got the ball rolling for most Asian currencies on Monday, sending the Japanese yen up over 1% against the dollar. That flowed through to big gains in other currencies such as the Australian and New Zealand dollars and Chinese yuan, the common denominator being each has been hammered over the past two months.

Adding the sizeable USD/CNH reversal, China's FX self-regulatory body, led by the PBOC, announced it would resolutely fend off risks of the yuan overshooting and pledged to take actions when needed to correct one-sided and pro-cyclical activities.

Gains accelerated further after the PBOC released monetary aggregates data for August, revealing new bank loans grew by 1.36 trillion yuan, up substantially from 345.9 billion yuan a month earlier and ahead of the 1.2 trillion yuan total expected by markets.

Total Social Finance – the broadest measure of credit creation in China – also improved, growing at an annual rate of 9%, up from 8.9% in the year to July. At face value, it suggests the drip-feed of modest policy easing measures announced recently is starting to flow through to the real economy, bolstering the case for a stabilisation in activity levels.

PBOC leaning against USD strength

That may help fuel a turnaround in the USD/CNH after what’s been a tough year.

Looking at the daily chart, it’s been pretty much nothing but one-way traffic in 2023: higher. While today’s candle is impressive, pointing to the largest gain since March, USD/CNH has tended to drift higher once coercion from official and quasi-official sources in China conclude, suggesting it’s too early to tell whether this is the start of a more meaningful reversal. But given the PBOC is deliberately leaning against USD strength, following the substantial weakening in the yuan this year, downside risks for USD/CNH may be more apparent over a medium-to-longer term.

For those seeking such a move, a push back towards 7.35 would improve the risk-reward of the trade, allowing for a stop to be placed either above Friday’s high of 7.3682 or the record high of 7.3750 set last year. On the downside, buyers may emerge on dips towards 7.2700, 7.2400 and again below the 7.1400, the top of a decent support zone in the past.

-- Written by David Scutt

Follow David on Twitter @scutty