Chinese Yuan Demands Attention from Crypto Traders

According to an observer, if the People's Bank of China (PBOC) decides to intervene in order to control the volatility of the yuan, it could potentially contribute to the strengthening of the dollar index and further worsen the challenges faced by the crypto market.

China's yuan (CNY), which is one of the five currencies included in the International Monetary Fund's special drawing rights basket, has experienced a 2.7% depreciation against the U.S. dollar (USD) this month, marking its poorest performance since September. Since February, the decline has reached 5% compared to the greenback, and financial giant Goldman Sachs suggests that there is potential for further drop.

In the past, the devaluation of the yuan has been seen as a positive factor for alternative assets like bitcoin and gold. However, the flip side of this situation is a stronger dollar. Currently, the U.S. dollar is already showing an upward trend, and if it continues to strengthen, it may lead to ongoing monetary tightening globally, creating challenges for risk assets, including cryptocurrencies, as noted by some observers.

The People's Bank of China (PBOC), the central bank of the country, loosely pegs the value of the CNY to a basket of 24 currencies through a managed-float system. The daily midpoint or fix is determined each trading day to provide guidance to the market. This currency basket represents China's trading partners, with the U.S. having the largest weightage at 19.83%. Other currencies in the basket include the euro, Japanese yen, British pound, Australian dollar, and Mexican peso, among others.

Under the PBOC's managed float policy, the yuan is allowed to fluctuate by 2% on either side of the daily fix. The central bank manages this band by actively buying and selling yuan. For example, if the USD/CNY exchange rate threatens to exceed the 2% limit, the PBOC sells dollars and buys yuan to support the value of the latter. At the same time, the bank purchases dollars against other currencies to maintain a stable proportion of the greenback in its reserves. This ensures that the intervention is recycled into other foreign currencies.

However, this process inadvertently exerts upward pressure on the dollar index, primarily composed of the euro and the Japanese yen. Consequently, it leads to financial tightening on a global scale and fosters risk aversion.

David Brickell, director of institutional sales at crypto liquidity network Paradigm, stated, "A USD/CNY rally means the PBOC will sell the pair to maintain the 2% band and has to buy the dollar against other currencies to maintain a stable proportion of USD in reserves. That pushes up the dollar index, leading to financial tightening and risk aversion." This situation poses challenges for entities that have borrowed in U.S. dollars but generate revenue in other currencies, as servicing their debt becomes difficult when the dollar strengthens. Brickell highlighted that over $17 trillion of USD debt has been issued outside the U.S. Consequently, dollar strength tends to create risk aversion on a global scale.

In this month alone, the dollar index has experienced a 2.7% rally. Conversely, bitcoin has declined by 7.3%, representing its most significant monthly loss since December.

Noelle Acheson, former head of research at CoinDesk and Genesis Trading, mentioned that while the PBOC's interventions may favor the dollar, it is not certain that such actions will persist. She emphasized that the PBOC has indicated a potential for more flexibility regarding the CNY target band compared to the past. Therefore, intervention may not occur, especially if a weaker yuan benefits exports, which are currently struggling. Acheson also pointed out that China's priorities have changed, and the PBOC has been diversifying its reserves, possibly opting to buy gold instead of accumulating more USD. 

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Tags : China yuan depreciation, CNY to USD exchange rate, Goldman Sachs forecast, Yuan devaluation impact, Fiat currency alternatives, Bitcoin and gold correlation, USD strength and risk assets, People's Bank of China (PBOC), Managed-float system, Currency basket composition,  Daily fix and market direction, PBOC intervention strategies, Dollar index and financial tightening, Risk aversion in global markets, Impact of USD strength on debt servicing, Global USD debt issuance, Bitcoin performance and market trends, PBOC's approach to CNY target band, Export implications of a weaker yuan, PBOC's reserve diversification and gold

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