CNY depreciation: A structural shift for Asia FX

The People's Bank of China (PBoC) has surprised markets for a third day with a weaker fixing at 6.4010, weaker than yesterday's spot close of 6.4083 and divergent with the overnight G7 spot action that pointed to a weaker USD fix against CNY. However, the PBoC is stating publicly it seeks convergence of the CNH and CNY rates and intervention is suspected in both markets. Additionally, it is pointing to the recent days of CNY depreciation as offsetting this year's 3% appreciation in trade-weighted terms. This suggests the PBoC is monitoring NEER levels and may now seek near-term CNY stability as the recent FX appreciation damage is undone. The urgency will shift to reducing volatility, risk premium and basis risk to cut RRR rates. 

"We continue to stress the medium term risks are for CNY depreciation and we revise our year-end 2016 USD/CNY forecast to 6.9, significantly (4.7%) weaker than the current onshore forward implied rate of 6.59," notes BofA Merrill Lynch.

It is argued that markets were being too complacent about depreciation risks. Indeed, this complacency still exists with the 1yr ADXY NDF pricing in 2.9% depreciation. Additionally, for a CNY depreciation profile of 5-10% over a 1-year horizon with the then forecasts of year-end 2015 and 2016 for 6.33 and 6.50, respectively, consistent with the 5% low end of the range. However, the last three days show every sign of China moving to a flexible exchange rate regime, which will have far reaching consequences for the rest of Asia FX. A structural break can be seen in the ADXY Asia FX index, with Asian currencies showing more volatility as a consequence of China's regime change.