"The continued devaluation of the yuan is definitely not conducive to the currency becoming internationalised. This is not our policy preference."

That’s from Chinese Premier Li Keqiang who spoke on Wednesday at the World Economic Forum in the northeastern port city of Dalian. Li also announced that China is set to allow foreign central banks access to the onshore interbank FX market, a move designed to buoy the country’s bid for SDR inclusion and hasten the currency’s internationalization.

Here’s what Irene Cheung, a currency strategist at Australia & New Zealand Banking Group in Singapore had to say about the above (via Bloomberg): 

"This is a step toward internationalization of the yuan [but] the gap between onshore and offshore yuan will narrow only when China’s economic fundamentals get better."

Or when the PBoC gets fed up and decides to intervene.  Read on. 

As the $94 billion FX reserve burn in August made clear, the yuan has come under continuous pressure in the wake of the PBoC’s switch to a new currency regime on August 11, reflecting the market’s expectation of a continually weaker currency. That pressure has manifested itself in the spread between the onshore and offshore spot which Beijing is keen on narrowing as part of the broader effort to rein in speculation that the yuan will continue to drop.

Late last month, in a kind of roundabout effort to narrow the spread, China slapped a 20% reserve requirement on FX forwards. That move, analysts said, was unlikely to do the trick. “The spread on CNY and CNH may not substantially narrow on this move alone, as global demand on dollar remains high and China economic growth remains slow,” Andy Ji, a Singapore-based currency strategist at CBA told Bloomberg at the time.

As we’ve seen with China’s efforts to arrest the SHCOMP’s terrifying slide and as is abundantly clear from the PBoC’s willingness to intervene heavily in the onshore FX market, China is perfectly willing to force the issue when things aren’t going its way, which is why it shouldn’t come as that big of a surprise that the PBoC looks to have intervened in the offshore spot market overnight (via agency banks of course) on the way to triggering the biggest CNH rally in history. Here’s Bloomberg: 

The yuan was headed for a record gain in the freely-traded offshore market, spurring speculation China’s central bank intervened to deter bets against its currency.

The yuan strengthened 1 percent to 6.4013 per dollar as of 6 p.m. in Hong Kong, poised for the biggest one-day advance since offshore trading began five years ago, according to data compiled by Bloomberg. The currency closed little changed in Shanghai at 6.3772 and its discount in the offshore market shrank to 0.4 percent from 1.4 percent.

“There is talk of intervention driving the offshore yuan,” said Khoon Goh, a Singapore-based strategist at Australia & New Zealand Banking Group Ltd. "It would seem that they are trying to dampen depreciation expectations and drive a narrowing of the onshore-offshore spread,” he said, noting that it is unusual for the People’s Bank of China to intervene outside of the domestic market.

Yes, “talk of intervention”. For those curious as to why traders are “talking”, here’s the chart:

Click on picture to enlarge

"China wants to converge the three yuan rates: the fixing, the onshore and offshore spot rates," Tommy Ong, managing director for treasury and markets at DBS Bank Hong Kong told Bloomberg, adding that “the fight has been quite extreme. There’s been quite a number of short yuan trades and volatility has jumped a lot, especially for the offshore yuan."

In what looks like confirmation of the above, traders reported "Chinese-named" banks selling USD/CNH, likely on behalf of the PBoC. Here's a bit more color from Reuters:

The intervention caught the market wrong-footed and was seen by traders as another bold gesture by Chinese authorities to shake out speculators and dampen expectations for further depreciation in the yuan following its devaluation in August.

The offshore yuan spot rate strengthened more than 1 percent to 6.39 per dollar from 6.4698 earlier in the day as the suspected intervention prompted those betting on yuan depreciation to cover their positions. Offshore traded volumes spiked as much as 10 times their monthly average, Thomson Reuters data showed.

The jump took the offshore yuan rate to its strongest level since early August when the central bank surprised markets by devaluing the currency nearly 2 percent.

"The big picture is that policy makers are doing everything they can do to dampen expectations that the yuan will depreciate much," said Mark Williams, an economist at Capital Economics in London.

"There's been rumours before of state entities acting on behalf of the central bank offshore. It shows that policymakers are unwilling to relax control of key variables that now include the offshore currency."

The offshore yuan discount to the onshore yuan spot market narrowed to 0.47 percent after the suspected intervention, from 1.56 percent on Wednesday.

"In the very extreme moment of the buying, we saw a rare reverse market quote in the Chinese currency which is an indicator that the buyers wanted to push up the value of the yuan at any cost," said the head of local currency trading at a U.S. bank in Hong Kong.

A "reverse market quote" refers to when the bid price is higher than the offer price, which traders said pointed to intervention.

"There are some Chinese banks steadily buying large amounts of yuan," said a trader at an Asia commercial bank in Hong Kong.

"But even if it is intervention by the central bank, I don't think it will change the expectation on the depreciation of yuan."

Maybe not, but it sure is amusing to watch. Note the rationale here: this is China intervening in the hopes that said intervention will make further intervention unnecessary. That is, rampant speculation that the yuan will continue to depreciate is forcing the PBoC to intervene in the onshore market and at an extremely high cost both in terms of the country's FX reserves and in terms of the deleterious effect the reserve liquidation has on liquidity. Devaluation expectations are at least partly manifesting themselves in the offshore spot market so ultimately, the PBoC figures it will try intervening there in the hopes that narrowing the spread will mean it has to intervene less in the onshore market. 

Summarizing the above in four words: one more spinning plate.

Bonus: color from Nomura on further efforts to reduce the onshore/offshore spread

The PBoC has relaxed the requirements for multinational corporations in China to participate in the cross-border RMB cash-pooling scheme. Under the scheme, MNCs in the Shanghai Free Trade Zone and several pilot cities are able to pool RMB cash to centralize and standardize risk management, debt service, and working capital transfers. 

With these changes, revenue requirements for participating companies’ onshore and offshore entities have been reduced to RMB1bn and RMB200mn respectively, from RMB5bn and RMB1bn previously. This enlarges the number of companies that can now participate.

More significant in our view, is that the PBoC has increased the upper limit for the net amount of inflow to the RMB cash pool 5 times by raising the Macro Prudent Policy Index to 0.5 from 0.1 previously. 

For CNH, the increase in capacity for corporates to remit RMB back into the onshore RMB cash pool will pressure USD/CNH lower [and] this measure will help to reduce the gap between onshore spot USD/CNH over spot onshore USD/CNY.