USD/CNY: Seven May be a 'Lucky Number' but Will the Exchange Rate Ever Reach It?

- Long arm of People's Bank of China seen interfering in currency markets.

- After allowing Renmimbi to weaken, the PBOC is now seen supporting it.

- Technicals show USD/CNY is still in an uptrend but the outlook is mixed.

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The USD/CNY pair is now unlikely to reach the 'lucky 7.00' level, according to analysts, as the People's Bank of China (PBOC) steps up its intervention in order to prevent a further depreciation.

The currency has weakened plenty since the start of the US-China trade war in the second quarter, with the USD/CNY rate rising from lows of 6.24 in March to 6.89 at the start of August.

Few saw an end to the depreciation in the short term since, if anything, as it was positive for Chinese exports because it made them cheaper to buy and also helped offset some of US tariffs imposed on Chinese exports in recent months. 

The PBOC now appears to have made a complete u-turn on its weak Yuan policy and there are now signs it is actively propping up the currency.

On Monday, Bloomberg News reported the Pboc had urged Chinese commercial banks not to engage in any “herd behaviour” and "momentum-chasing moves in the currency market."

"It’s a signal that the PBoC is alert to the risks facing the yuan and doesn’t want to see the currency as a one way bet," says Jason Wong, an analyst at BNZ Bank.

Recent comments from a senior PBoC adviser, Sheng Songcheng, that USD/CNY is 'unlikely to break through the 7.00 level' also led to speculation the central bank was intervening to stop the Yuan rout.

Yet Chinese FX reserve data out on Tuesday failed to confirm any intervention after it showed reserves rising to $3.118 trillion, from $3.113 trillion previously, and not a fall to the $3.10 trillion that consensus had predicted that one would expect if the central bank had been buying Renmimbi.

"The Wall Street Journal reported traders seeing the PBoC intervening aggressively in the lower-profile FX forward swaps market to help contain the depreciation of the yuan," Wong adds. "The stronger forward exchange rate as a result of the PBoC actions provides a warning signal for those who want to short the yuan aggressively."

The market appears to be playing ball, according to options data anyway, which shows implied volatility in USD/CNY falling. This suggests traders see less movement in the USD/CNY exchange rate during the days and weeks ahead.

Above: Bloomberg News graph showing implied volatility in USD/CNH exchange rate.

Option 'risk reversals', which provide insight into market expectations for the direction of an exchange rate, have also pointed toward stability in the USD/CNY rate as traders are no longer piling into trades that would protect them against further Renmimbi weakness.

Above: Bloomberg News graphs showing USD/CNH risk reversals 

"USD/CNH vols and the CNH put bias on risk reversals have eased as the yuan settles below its worst and dealers expect the PBOC to limit any further weakness toward 7.00," says Richard Pace, a correspondent for Reuters. "Even if CNH is hit again, dealers feel PBOC will step in to limit losses. Since mid July, options were never expecting spot to get above 7.00."

Yet what of technical studies? Do they too suggest 7.00 will remain forever out of reach? The overarching USD/CNY trend remains very much of the bullish variety. Further, it has formed a Japanese candlestick pattern, called a hammer, which is also quite bullish.

Not only that, but the hammer has formed in what some traders call the 'buy zone' of the chart - the space between the 10 and 20 day moving averages (MA) - which is the perfect place to go long after a pause in an uptrend.

Above: USD/CNY rate shown at daily intervals.

Everything is saying 'buy' yet what is concerning about the chart is the long, bearish, shooting star that has formed at the August 3 (circled) peak, which might well have marked a major high for the pair. While it might be tempting to make a bullish call due to the buy zone hammer set-up, the shooting star calls for caution. 

Ultimately a break above the 6.8925 August highs would be necessary to herald a continuation of the bullish trend onward and upward to the 'lucky number' 7.

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