China yuan sags vs dlr in NDFs, depreciation seen
Reuters - Wednesday, September 17By Lu Jianxin

SHANGHAI, Sept 16 - China's yuan fell sharply against the dollar in the offshore non-deliverable forwards market on Tuesday, with one-year NDFs implying yuan depreciation over the next 12 months for the first time in five years.

The drop suggested overseas investors were becoming increasingly concerned about the health of China's economy and asset markets, partly because of Monday's surprise monetary easing by the central bank.

The Chinese currency also fell against the dollar in the spot market, nearing the lower edge of its daily trading band, 0.5 percent below the day's central bank-set mid-point <CNY=SAEC>. It was one of the few times since the yuan's peg to the dollar was scrapped in July 2005 that it neared an edge of its trading band.

The central bank said on Monday that it was cutting its benchmark lending rates and lowering smaller banks' reserve requirements, in what many analysts saw as an effort to improve sentiment in the stock and property markets.

But the easing failed to achieve this -- the Shanghai Composite Index <.SSEC> sank 4.47 percent to a fresh 21-month closing low on Tuesday. Instead, the easing may have caused some foreign institutions to believe that China's economic prospects were weakening beyond expectations.

"The monetary easing is negative for the yuan as it prompts investor worries about China's economic prospects," said Liu Dongliang, currency analyst at China Merchants Bank in Shenzhen.

"But analysts here believe the central bank will still try to maintain the stability of the yuan. So the market is likely to become very volatile in the near term."

NDFS

One-year dollar/yuan NDFs <CNY1YNDFOR=> surged to a fresh year-high of 6.8285 in late trade on Tuesday from Friday's close of 6.7500. Monday was a national holiday in China.

The high implied yuan depreciation against the dollar of 0.12 percent over the next 12 months from the day's spot mid-point of 6.8203. It was the first time that one-year NDFs implied yuan depreciation since September 2003. On Friday, NDFs implied 12-month yuan appreciation of 1.42 percent.

In recent years, one-year NDFs had consistently implied yuan appreciation because of China's strong economy and huge trade surplus. Implied appreciation hit a peak of 13.79 percent in March this year as China used currency strength to fight inflation.

But since then, the yuan has weakened in the NDF market because of the dollar's strength in global markets as well as slowing Chinese inflation and economic growth, which have caused Chinese authorities to shift the focus of economic policy towards sustaining growth.

Offshore one-year dollar/yuan volatilities <CNY1YO=> rose sharply to a one-week high of 8.25 percent bid from Friday's 7.70 percent close in response to the shift in the NDF market.

SPOT YUAN

Before trade began on Tuesday, the central bank set the yuan's mid-point against the dollar at 6.8203, up 0.37 percent from Friday's 6.8458 in the biggest daily rise since June 2007.

"The central bank sent a signal to the market that it would not allow the yuan to depreciate for now, despite its easing of monetary policy," said a dealer at a major Chinese commercial bank in Shenzhen.

"A weak yuan would ignite capital outflows out of China amid the collapse of the Chinese stock market and the weakening of the property market."

But the mid-point signal failed to have a sustained impact as the yuan <CNYX=CFXS> slid for most of the day. It opened sharply higher at 6.8230, but quickly pulled back and closed at 6.8490, down from Friday's finish of 6.8450.

The yuan closed 0.42 percent below its mid-point, an unusually large distance in a market which regularly takes its cue from the central bank's reference rate.

Traders expect the central bank to continue using its mid-point system and indirect intervention if necessary to support the yuan, and do not see a significant chance of the market testing the lower edge of the trading band aggressively.

If the NDF market begins to imply a large amount of yuan depreciation, the central bank could guide the spot rate to squeeze NDF speculators, as it did earlier this year when the NDF market showed excessive expectations for yuan appreciation.

Nevertheless, the yuan's weakness on Tuesday showed the markets see little room for the yuan to appreciate, even in the long term, because of China's uncertain economic outlook.

"We expect the central bank to keep the yuan largely stable for the rest of this year, though its movements will continue to be affected by the dollar's global performance," said a dealer at a major U.S. bank in Shanghai.