The New Yuan Peg: Here's What It May Mean

After taking their first step towards a more flexible currency back on July 21st, we have not heard much from China since then. At the time, China had revalued their currency by 2% to 8.11 against the dollar and announced their decision to allow the Yuan to fluctuate 0.3% intraday with a new closing price set at the end of each trading day.  They also announced their intentions to move to a managed floating exchange rate against a basket of currencies. Since then, we had been waiting for China to disclose the components of the basket and that was exactly what we saw this  morning.

The People's Bank of China said today that the main components of the basket will be the US  dollar, the Euro, the Japanese Yen and the South Korean Won. Other currencies holding a lesser weighting in the basket are the Singapore dollar, the British pound, the Malaysian Ringgit, the Australian Dollar, the Russian Ruble, Thai Baht and Canadian Dollar.  Although the exact percentage weightings were not disclosed, and we had expect China to mimic Singapore in not doing so, they did say that the weights will be based upon how much trade each country does with China as well as how much debt China owes to each country. China has refrained from disclosing the basket weightings because it would provide too much information for speculators. We have long  forecasted on www.chinarevaluation.com that if China decides to peg the Yuan against a basket of  currencies, that the basket would have to include their largest trade partners. As of last year,  Europe, the US and Japan constituted China's largest trade partners. With the value of trade between China and Europe and China and the US fairly close, we expect the dollar and the euro to constitute very similar weightings in the basket with the Japanese yen tracking not far behind. This announcement has been and will continue to be very positive for the Japanese Yen and the Euro as the China, one of the biggest players in the global reserve market gradually aligns their reserve holdings with the reference basket for their managed float. China also announced today that they will allow banks who conduct over $2 billion in foreign trade to trade Yuan forwards and swaps.

The target of a floating exchange rate still remains a possibility, but for now, we think that China is quite satisfied with the significant changes that they have made lately and will probably take some time to digest their latest changes.  We do not expect China to make another move for at least a few months, but what we do see, and what we expect to be consequence of China agreeing to revalue is increased talk of Chinese firms looking abroad for acquisition targets.

Kathy Lien

Kathy Lien is the Chief Currency Strategist at Forex Capital Markets. Kathy is responsible for providing research and analysis for DailyFX, including technical and fundamental research reports, market commentaries and trading strategies. A seasoned FX analyst and trader, prior to joining FXCM, Kathy was an Associate at JPMorgan Chase where she worked in Cross Markets and Foreign Exchange Trading. Kathy has vast experience within the interbank market using both technical and fundamental analysis to trade FX spot and options. She also has experience trading a number of products outside of FX, including interest rate derivatives, bonds, equities, and futures. She has a Bachelors degree in Finance from New York University. Kathy has written for Stocks and Commodities, CBS Market Watch, ActiveTrader, Futures and SFO Magazine. She is frequently quoted on Bloomberg and Reuters and has taught seminars across the country. She has also hosted trader chats on EliteTrader, eSignal, and FXStreet, sharing her expertise in both technical and fundamental analysis