China's FX market developments – New geographies, new products

The CNY's substantial undervaluation in the mid-2000s has likely been fully corrected. This, alongside China's smaller external surpluses, creates a window of opportunity for the authorities to give market forces a bigger role in driving FX. 

"The Q2-2015 lull in USD-CNY spot volatility is likely to be short-lived, and corporates need to prepare for more volatility in the medium term. The PBoC has likely already stepped back from routine FX market intervention. It is expected to widen the onshore USD-CNY trading band to +/-3% by end-2015 and to +/-5% by end-2017, from +/-2% now. The importance of the PBoC's fixing is likely to be much diminished by 2018, and corporates now have a powerful incentive to use deliverable markets for accounting and hedging purposes. A tangible evidence of a marked slowdown in trade volumes in the non-deliverable forwards is seen", according to Standard Chartered. 

USD-CNH has become an excellent proxy for the onshore USD-CNY spot exchange rate. While the gap, or 'basis', between the twin spot rates may become more volatile as USD-CNY spot volatility picks up, there are powerful forces that should correct any short-term divergences. In the offshore market, the volume of options trading may have exceeded that in some G10 currencies in early 2015. USD-CNH option-implied volatilities are arguably still well contained given prospective higher FX volatility and the carry offered by CNH.