Despite rising expectations of a U.S. Federal Reserve rate hike, the Chinese yuan has soared back unexpectedly since last week encouraged by a new yuan-dollar pricing formula and resilient economy.
The yuan's central parity rate against the U.S. dollar on Tuesday strengthened for the fifth trading day to stand at 6.7934, the strongest level since last November, according to the China Foreign Exchange Trade System (CFETS).
Both onshore and offshore yuan stayed steady at around 6.8 and 6.78, respectively.
The market had predicted that the currency might experience a new round of downward fluctuations as risks from a weakening U.S. dollar were fully unleashed. By the end of May, the dollar index, which measures the greenback against six major peers, had declined around 4.1 percent from 101.16 registered on April 7.
However, the recent appreciation has caught many investors unprepared. On June 1, the yuan went up 543 basis points, or 0.8 percent, a rare and huge increase in a relatively stable market.
"An offshore liquidity tightening boosted the cost of short-selling and magnified the yuan's appreciation against the U.S. dollar, which then spread to the onshore market," said Bai Ming, a veteran analyst on global markets with China's Ministry of Commerce. "On this basis, China's decision to incorporate a 'counter cyclical factor' into its yuan's pricing mechanism further discouraged short-sellers."
The CFETS, a public institution under China's central bank, said on May 26 that the country was considering a new yuan-dollar pricing formula to curb volatility.
With the "counter cyclical factor," the new formula will be able to hedge against fluctuations in market sentiment and alleviate the herd behavior of investors, the CFETS said. It did not disclose detailed plans but said a number of dealer banks had already made adjustments.
Japanese brokerage Nomura said in a report that the move had prevented the yuan's depreciation expectations in the short term.
It is "part of a broader effort to ensure market stability ...following the Moody's downgrade," Bloomberg economist Tom Orlik said, considering the yuan's current appreciation a cushion against impact from an expected mid-June Fed rate increase.
If that becomes reality, the U.S. rate hike will likely send the dollar index into a gaining streak again and renew liquidity pressures on emerging markets, including China.
But at least for now, analysts believe more room has been unlocked for the yuan to continue its rising trajectory, while still cautioning against a potential economic downturn and capital outflows.
UBS economist Wang Tao expects the yuan to not move beyond 7 against the greenback by the end of 2017 and to remain relatively stable in 2018. Similarly, HSBC said on Tuesday the currency would come to around 6.9 for the end of the year, revised from its previous 7.1 forecast, and recognized China's efforts to introduce greater flexibility for two-way trade.
The yuan's pricing mechanism has been revamped over the past years to become more market-oriented as China has been keen to push for the internationalization of the currency.
Chinese foreign exchange regulars have said the yuan's rate would ultimately be determined by economic fundamentals and remain basically stable.
The official manufacturing Purchasing Managers' Index expanded for the 10th straight month in May, suggesting a stabilizing economy. The GDP grew 6.9 percent year on year in the first quarter, the fastest increase in a year and a half.
