FX Daily: Quiet G10 markets despite Chinese turmoil

Beijing continues to fight the recent turmoil on multiple fronts: real estate, financial, and the FX market. Overnight, the PBoC set the CNY fixing with the largest gap to estimates in order to curb bearish speculation. Despite all the turmoil in China, G10 volatility has remained capped, and this is probably why Japanese authorities are not intervening.

USD: Chinese authorities go all in to defend the yuan

Developments in the distressed Chinese financial and property sector are emerging as the most prominent driver for market sentiment, especially after the Fed minutes proved to have limited implications for central bank expectations and developed market calendars are quite light. Overnight, Chinese authorities turned their focus on the FX market, deploying what is now regarded as the biggest defence of the yuan via fixing guidance on record. The People's Bank of China (PBoC) fixed USD/CNY at 7.2006, significantly below the average estimate of 7.305, which marks the largest gap compared to the estimate since the poll started in 2018.

Today’s PBoC move follows yesterday’s reports that state-owned banks were asked by Chinese authorities to step up yuan interventions to reduce FX volatility. We could also see a cut in FX reserve requirements, often considered as a tool to avert sharp CNY depreciation.

So far, the spillover into G10 currencies has been limited. The highly exposed AUD is down 1.4% this week, a relatively contained slump considering the amount of bad news that has piled up in the past few days. This is probably a signal of how AUD was already embedding a good deal of negatives related to China and how markets are expecting government intervention to avert black swan scenarios.

This morning, the emergency yuan fixing has left FX markets quite untouched, with the exception of USD/JPY trading on the soft side, likely due to Japan’s service inflation hitting 2% for the first time in 30 years overnight. Incidentally, the pair is well into FX intervention territory but is probably missing enough volatility to worry Japanese officials. Still, the oversold conditions of JPY and the threat of interventions are likely going to exacerbate any USD/JPY downside corrections.

The US calendar is empty today and the focus will likely be on bond market dynamics after back-end yields touched fresh multi-year highs yesterday. The combined effect of high yields and growing risks in China suggests the balance of risks is moderately tilted to the upside for the dollar. A return to 104.00 in DXY remains a tangible possibility in the coming days.