The Chinese government is mulling a pivotal adjustment to the models that it uses to determine the Renminbi’s central parity rate against the greenback, with a view to stymieing excessive volatility.
The China Foreign Exchange Trade System has announced that it is considering the introduction of a “counter-cyclical factor” to the current pricing model, as part of efforts to curb pro-cyclical fluctuations caused by what it refers to as “irrational sentiment” on the forex market.
The central parity rate of the Chinese yuan against the dollar is currently based on a weighted average of quotes provided by market makers, whose models are based on factors in including rate changes compared to a basket of currencies as well as the prior day’s closing rate on the interbank forex market.
The central parity rate is then used as the key benchmark the spot market price, which is permitted diverge from it by 2% either way each trading day.
In CFETS’ opinion the models currently used fail to take into account the fact that the foreign exchange market is characterised by irrational “pro-cyclical” expectations, which warp demand and supply as well as heighten the risk of excessive market responses.
The introduction of a counter-cylical factor as proposed by the China FX Committee would correct this problem and instead focus market attention on macroeconomic performance.
Adjustments to the counter-cylical factor would also enable the central parity rate to serve as a more accurate reflection of China’s macroeconomic performance, as well as foreign exchange supply and demand.
According to the proposal the specific parameters for the model would determined by market maker banks based on their own expectations of future macroeconomic and forex market performance.
The announcement comes close on the heels of a recent report by the Wall Street Journal claiming that China has unofficially re-pegged its official currency to the US greenback following the election of President Trump.
Robin Brooks, chief economist at the Institute of International Finance and erstwhile currency strategist, said to WSJ that China’s management of its currency underwent a significant change following President Trump’s election, with Beijing essentially re-anchoring the RMB to the dollar.