Finally Chinese Central banker are making some real beneficial policy. I think it is a very clever move for PBOC to widen its trading band of Yuan to 2% from 1%, as this really help Chinese economy shake out hot money from the financial system, thereby improving effectiveness of monetary policy. What do I mean by this?
For many who may not know about Chinese exchange rate regime: China is one of the very few peculiar country using “managed floating exchange rate”. The key word here is “managed”, which means People’s Bank of China set daily peg for trading of the yuan against the U.S. dollar (a.k.a. the parity rate, albeit the fact that this is not market determined). Then the trading would start for the day where price cannot exceed 1% above or below the parity rate. If the price ever exceed this band, then the PBOC would step in and intervene the market.
Last Saturday, PBOC announced it would let the trading range widen to 2%. This might not sound like much, but as little as 1% has significant influence in the forex market. You could see a reaction to this is that the yuan fell to its lowest level in 10 months, sparking paper losses estimated in the billions of dollars on leveraged bets that the currency would keep appreciating. Individual and institutional investors have been piling up options that would magnified gains when yuan was appreciating but also causing more losses if the yuan falls below a certain level.
Why is PBOC doing this to the poor investors? Well, as the saying goes, there is no free lunch.