China Maintains Yuan Support Via Daily Fixing Amid Trade War

The People's Bank of China (PBOC) has been employing a daily fixing mechanism to maintain the stability of the yuan amid the ongoing trade war with the United States. This policy tool, which sets a reference rate for the yuan against the US dollar, has been crucial in managing market expectations and curbing speculative behavior. However, the effectiveness of this mechanism has been challenged by several factors, including market expectations, speculative behavior, volatility, and geopolitical uncertainties.

The daily fixing mechanism, implemented in 2005, allows the yuan to fluctuate within a 2% band around the fixing rate. This mechanism has been a key tool for the PBOC in maintaining the yuan's stability and preventing excessive volatility. However, the effectiveness of this mechanism has been called into question in recent years, as market participants have become more sophisticated and better equipped to anticipate the PBOC's policy moves.

One of the main challenges faced by the PBOC in implementing the daily fixing mechanism is managing market expectations and speculative behavior. Market participants often form expectations about the fixing rate based on their interpretation of the PBOC's policy intentions and market conditions. These expectations can, in turn, influence the fixing rate itself, creating a self-reinforcing cycle. To address this issue, the PBOC has introduced a counter-cyclical factor in the fixing formulas to prevent the fixing rate from becoming excessively weak or strong.

Another challenge for the PBOC is the impact of volatility and market sentiment on the fixing rate. Offshore RMB volatility can dampen the effect of the fixing rate on the market, making it more difficult for the PBOC to maintain the yuan's stability. Additionally, market sentiment can influence the fixing rate, as market participants may be more or less inclined to buy or sell the yuan based on their perceptions of the currency's value and the broader economic outlook.

The trade war with the United States has added further pressure on the yuan, making it more challenging for the PBOC to maintain stability. The depreciation of the yuan in August 2015, following a change in the fixing mechanism, highlighted the vulnerability of the currency to external shocks. Since then, the PBOC has taken steps to strengthen the yuan's resilience, including the introduction of the counter-cyclical factor and the use of administrative measures to discourage speculative behavior.

In conclusion, the daily fixing mechanism has been an essential tool for the PBOC in maintaining the yuan's stability amid the ongoing trade war. However, the effectiveness of this mechanism has been challenged by market expectations, speculative behavior, volatility, and geopolitical uncertainties. To address these challenges, the PBOC has introduced the counter-cyclical factor and employed administrative measures to manage market expectations and curb speculative behavior. As the trade war continues to evolve, the PBOC will need to remain vigilant and adapt its policies to maintain the yuan's stability and support the broader economy.