China’s yuan (CNY) has recently experienced a 2.7% depreciation against the U.S. dollar (USD) this month and a 5% decline since February, according to investment banking giant Goldman Sachs. As one of the five currencies in the International Monetary Fund’s special drawing rights basket, yuan devaluation has historically been considered bullish for alternative assets such as bitcoin and gold. Nevertheless, the other side of the coin is the strengthening U.S. dollar, which could lead to continued monetary tightening worldwide and potentially pose a headwind for risk assets, including cryptocurrencies.
The People’s Bank of China (PBOC) loosely pegs CNY’s value to a basket of 24 currencies through a managed-float system, with the USD having the highest weighting at 19.83% due to the U.S. being China’s largest trading partner. The PBOC’s managed float allows the yuan to fluctuate 2% on either side of the daily fix, which is managed through active buying and selling of the yuan. If the USD/CNY ratio threatens to rally beyond the 2% limit, the PBOC intervenes by selling the dollar and buying the yuan to maintain the former’s value. This intervention process inadvertently puts upward pressure on the dollar index, causing financial tightening worldwide and leading to risk aversion.
David Brickell, Director of Institutional Sales at crypto liquidity network Paradigm, explained the situation: “USD/CNY rally means PBOC will sell the pair to maintain the 2% band and has to buy the dollar against other currencies to maintain a stable proportion of USD in reserves. That pushes up the dollar index, leading to financial tightening and risk aversion.” This could create difficulties for those with borrowings in the U.S. dollar and receipts in other currencies, leading to risk aversion worldwide.
However, it is essential to note that PBOC interventions may be dollar bullish, but these actions are not guaranteed. Noelle Acheson, former Head of Research at CoinDesk and Genesis Trading, pointed out that “the PBOC has been hinting at more flexibility on the CNY target band than in the past – so it’s not a given that it will intervene, especially if a weaker yuan helps exports (which are suffering).” PBOC has been diversifying reserves and might opt to buy gold instead of more USD.
PBOC Governor Yi Gang has previously stated that the central bank could end regular interventions, allowing market forces greater influence on the yuan’s exchange rate. Nonetheless,
Source: Coindesk
