Step aside Powell: what may be the most important news for the dollar today came not from Jackson Hole but from Beijing, where the People’s Bank of China unexpectedly announced that it would resume use of the “counter-cyclical factor” in the CNY midpoint fixing mechanism, which it suspended in January, sending the Yuan sharply lower at the time.
As Bloomberg reports, banks that contribute to the fixing plan to resume re-applying the counter-cyclical factor in their calculations from Monday, “while a source from a yuan-fixing bank said the institution has already resumed using the counter-cyclical factor, without saying if the bank received a call from the PBOC.”
What is the counter-cyclical factor?
As a reminder, back on May 26, 2017, shortly after Moody’s downgrade of China, Beijing “moved the goalposts” in its bid to reduce yuan volatility and depreciation, to punish currency manipulators (read Yuan shorts) and limit capital outflows (the currency had weakened for three straight years, triggering draconian capital controls and the surge of bitcoin) when the PBOC introduced a new “counter-cyclical factor” to reduce exchange-rate volatility, mitigate “pro-cyclicality” of market sentiment and reduce “herd behavior” in the FX market
As we explained at the time, under the new reference rate formula unveiled by the PBOC, institutions that provide quotes for the fixing would add an “intangible” counter-cyclical factor to their existing models, which takes into account the previous day’s official closing price at 4:30 p.m. as local time and changes in baskets of currencies.
In an amusing aside, to justify the move, China stated that its “foreign-exchange market can be driven by irrational expectations, resulting in “unreal” supply and demand that increases the risk of overshooting… The counter-cyclical factor may ease “herd actions” and help guide investors to pay more attention to economic fundamentals, according to the statement.”
In other words, instead of “countercyclical”, the PBOC could have just called it a “fudge” factor, whose purpose was to tell the market that the change in yuan rate during any given day should not be validated by incorporation in the next fixing if the economic fundamentals do not warrant it.
In short, the factor’s return is just another way for the PBOC to strengthen the Yuan and it may explain why just two hours ahead of the Bloomberg flashing red headline, the USDCNY inexplicably plunged in afterhour markets as news of the resumption leaked across Chinese trading desks.
And sure enough, the USDCNH has continued to slide, dropping as low as 6.8264 from an overnight high just shy of 6.90.
As Bloomberg notes, “with the recent uptick in Asian exports and even Turkey’s recent descent from the front page headlines, this sort of measure could help provide a bit of stability to EM.”
No, it won’t eliminate the impact of further Fed tightening (and it seems unlikely that Powell will waver from the path this morning), but it might mitigate some of the ancillary concerns.
To be sure, the latest intervention by the PBOC should serve as the latest support for the Yuan at a time when as we noted last night, trade talks between China and the US had broken down with no tangible results, threatening to push the Chinese currency to the key level of 7.00 against the dollar if not lower.
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