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Yuan rallies to strongest in two years in renewed test for the central bank

Yuan rallies to strongest in two years in renewed test for the central bank

Beijing: The yuan climbed to its strongest level since July 2018, presenting China’s central bank with another test of how much appreciation it will tolerate.

The yuan gained as much as 0.25% to 6.6602 a dollar on Wednesday morning in Shanghai. The People’s Bank of China earlier fixed its daily reference rate at 6.6781, which was slightly weaker than expected.

The latest push higher will have traders watching to see whether the People’s Bank of China acts to slow gains. One of its preferred measures is to fix the currency’s daily reference rate - which limits moves to 2% in either direction - at levels weaker than market watchers expect. It also has other tools at its disposal, such as relaxing capital controls installed after a shock devaluation five years ago and mobilizing state-backed banks to sell the yuan.

“The PBOC will take this week’s yuan strengthening as too fast,” said Nathan Chow, a senior economist at DBS Bank Ltd.’s Hong Kong branch. “It will send signals verbally or through the fixing rate. They could ask Chinese banks to buy U.S. dollars.”

The PBOC said on Oct. 10 it was scrapping a rule that made it expensive to bet against the yuan. In the first session after that change, the onshore yuan slumped the most in nearly seven months.

The currency of the world’s second-largest economy has surged more than 4.7% over the past three months, the most in Asia after the South Korean won. In addition to dollar weakness, the yuan is being underpinned by a wide interest-rate premium over the rest of the world. China’s 10-year government bond yields are at 3.20%, sending the gap versus the yield on U.S. Treasuries to near the highest on record.

The yuan’s rally has also been aided by the economy’s rebound from the virus pandemic. That recovery continued in the July-September period, when gross domestic product expanded by 4.9% from a year earlier. The prospects of a victory by Joseph R. Biden Jr. over Donald Trump in the upcoming U.S. presidential election are also supporting the currency. Trump’s trade war with China last year sent the currency to its lowest since 2008.

Traders are pricing in bigger swings by the yuan before the poll on Nov. 3. The offshore yuan’s one-month implied volatility has climbed to 7.3%, near the highest level since March.