It was only last week that the People’s Bank of China (PBOC) was rumoured to be competing in the currency market, which was coincidentally followed by a Moody’s downgrade. The action demonstrated signs that positions have been cut at a loss for anyone who attempted to short the Yuan. The O/N (overnight) and T/N (Tom-next) rates ballooned today which makes running currency short positions extremely expensive to finance. The currency traded from 6.85 down to below 6.77 (off-shore) as dealers scrambled to cover short positions as everyone chased for financing. The rates market moved from around 5.25% to over 21% to cover short-term (o/n and t/n) positions.
This is a popular move often undertaken by central banks if they fear the market is challenging them. The Bank of England when the GBP was forced out of the ERM raised rates to over 15% from then 11%. However, it is interesting that the options markets has (so far) seen this as a temporary move and has priced longer dated trades with only minimal impact. Many are speculating, given the new fixed approach China has taken against the USD, whether this is a friendly move to help a new President address his concerns over currency manipulation and assist a weaker USD!
