As we discussed earlier this week, a new conundrum had emerged in the market: instead of rising on good news, and a Fed clearly determined to hike rates, the dollar has been sliding (read our explanation here). But for China, which is now in easing mode, and is increasingly concerned what rate differential will do to the Chinese economy once the Fed begins tightening, the drop in the dollar appears to not be nearly enough and on Thursday, the Chinese central bank set the yuan's reference rate at the weakest relative to expectations in a month. The PBOC set the daily reference rate at yuan fixing at 6.3542 per dollar, which as shown below was 60 pips weaker-than the average estimate of 6.3482, the biggest discount relative to expectations in over a month.

The spread between the daily yuan fix and expectations is charted below, and it shows that with a handful of exceptions, the yuan has been fixed well below expectations for much of the past 4 months.

(Click on image to enlarge)

“Today’s fixing was weaker than expected, and an indication that the authorities do not want the yuan to strengthen past the 6.35 level yet,” said Khoon Goh, head of Asia research at ANZ in Singapore. “However, with China still running large trade surpluses, portfolio inflows strong and the USD now turning lower, it may be difficult for the authorities to prevent the yuan from strengthening anyway.”

Exporters will be more actively converting foreign currency holdings into yuan to pay bonuses and other festival-related spending ahead of Lunar New Year, lending further support to the yuan.

“We have seen large fixing deviations before, and they tend to be a one-off. Tomorrow’s fixing therefore will be closely watched.”

While it is still early to conclude that Beijing is freaking out about a strong yuan, it appears that we start 2022 with an even bigger conundrum. Not only is the dollar losing altitude as the US prepares to hike as much as four times this year, the appreciation pressures behind the yuan remain intense even as China is preparing to ease to stabilize its flailing property developers. Somehow we doubt that this will be the biggest market paradox of what is sure to be a very "interesting" year.