Downside in USD-CNY likely limited

The spread between CNY and CNH widened to around 400pips this week, while it was almost zero two weeks ago. This is a bit surprising as Chinese authorities have committed to narrow the CNY-CNH spread in order to facilitate the SDR decision in November. 

In the IMF's SDR review report, it clearly stated that deviations between the CNH and CNY raise potential operational issues as CNH cannot be used as a perfect hedge for CNY-based exposure. 

The other fact is hedging products in CNH market are more sophisticated and the liquidity is much deeper. Therefore, a significant deviation between CNY and CNH could cause difficulties to other central banks if CNY is included into the SDR basket. 

"Given that China's capital account is largely closed, in order to narrow the CNY-CNH spread, what China can do is to intervene into the offshore CNH market. That said, the widening spread in recent weeks indicates that China's central bank has become less active in CNH market", says Commerzbank. 

This would suggest that the downside in USD-CNY is limited as corporates that need to purchase USD would see it now as more attractive to buy USD-CNY in the onshore market.