China-based traders believe that the country’s central bank has moved towards the use of low-profile forex swaps to bolster its currency rather than the traditional method of selling high quantities of US dollars to buy renminbi.
Official data released on Tuesday showed that China’s foreign exchange reserves actually increased for the second straight month in July to about $3.12 trillion from $3.11 trillion, indicating that the People’s Bank of China has not been selling off its dollar holdings.
“The PBOC is guiding people’s expectations in the forward market as it doesn’t want to waste money in the spot market. Without action in the forward market, the yuan’s depreciation could have been far worse,” Suan Teck Kin, an economist at United Overseas Bank, told the Wall Street Journal.
By using state-owned banks as proxies, the People’s Bank has bought masses of dollar-yuan swaps to build a stronger outlook for the renminbi. High demand for such swaps – whereby dollars are bought now to be sold in a year’s time – push down the price of forwards and with it the spot-exchange rate.
The central bank’s aggressive buying has driven the one-year dollar-yuan swap spread down to 6.8064 for a year from now compared the spot rate of 6.8330. This difference was positive just two months ago.