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Chinese state-owned banks are driving a rally in the yuan against the weakening US dollar, as revealed by undisclosed sources cited by Reuters. Traditionally known for selling dollars to prevent

the yuan's decline, these banks have taken an unexpected turn by buying yuan this week, resulting in a 2% gain. This gain has positioned the currency at around 7.13 to the dollar, marking its highest value in almost four months.

Observers suggest that this surprising move aims to accelerate the yuan's appreciation, urging exporters to convert more foreign exchange receipts into yuan. Market analysts believe that state banks have engaged in their typical combination of swaps and spot market activities. They've been observed exchanging yuan for dollars in the onshore swap market and subsequently selling those dollars in the spot currency market.

This activity aligns with the broader trend of a weakening US dollar, which has seen the dollar index decrease over 3% in November. This decline is attributed to declining US yields amidst signs indicating a peak in Federal Reserve monetary tightening. Despite these recent gains, the Chinese currency remains down over 3% against the dollar for the year.

The state banks' selling activities momentarily pushed the onshore spot yuan to 7.1296 per dollar, surpassing its daily official guidance for the first time in four months. The People's Bank of China (PBOC) has consistently lowered the dollar-yuan daily fixing rate this week, setting it at a three-and-a-half month low of 7.1406 per dollar on Tuesday.

Analysts speculate that these actions might be preludes to a potential policy rate cut, taking advantage of the current external environment to bolster the Chinese yuan (CNY).

Kiyong Seong, the lead Asia macro strategist at Societe Generale, highlighted the continuous lowering of the fixing rate as an indication of preparations for a policy rate cut, expressing surprise at this move.

Despite uneven economic recovery in China, with positive surprises in industrial output and retail sales, concerns linger about the potential impact of further monetary easing on the Chinese currency.

While the People's Bank of China has been injecting cash through medium-term lending facility loans, the rate has remained unchanged, leading analysts to anticipate more policy easing in the future.

Zhi Xiaojia, chief China economist at Credit Agricole, cautioned about potential volatilities unless significant dollar downside moves or positive sentiment events occur. However, she maintains a relatively optimistic view on the yuan's outlook for the rest of the year and 2024. She emphasizes the wide yield gap and expectations of further policy easing, including potential rate and reserve requirement ratio cuts by the People's Bank of China. Photo by Carpkazu, Wikimedia commons.