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    Yuan rebounds from 5-month lows on China trade data ahead of holiday weekend

    Imports to China fell by less than expected in May, raising hopes that domestic demand in the world’s second largest economy is strengthening. Chinese imports have been declining on a year-on-year basis since November 2014 as the economic slowdown has led to lower demand for international goods and raw materials.

    May imports were down 0.4% on an annual basis, the lowest decline since December 2014 and above estimates that they would fall by a much larger 6.0%. Exports were slightly below expectations though as they fell by 4.1% in the 12 months to May, versus forecasts of a 3.6% drop. As a result, the trade surplus also missed forecasts, but was still up on the previous month at 49.98 billion yuan.

    The trade figures contributed to the risk on sentiment in Asian trading today ahead of the long holiday weekend in China, helping the yuan firm at the start of Wednesday trading. However, analysts cautioned that the rise in imports is likely due to the higher commodity prices and there’s little sign yet of exports recovering. In fact, exports in the coming months could fall more sharply as the Chinese government moves ahead with its structural reform plans to reduce overcapacity in the manufacturing sector.

    The People’s Bank of China today cut its forecast for export growth in 2016 from 3.1% to -1.0%. However, it upped its estimate of fixed-asset investment growth from 10.8% to 11.0% and maintained its GDP growth forecast at 6.8%. The PBOC also raised its inflation forecast for 2016, from 1.7% to 2.4%, in a sign that the downwards pressure on prices since 2014 is abating.

    In the meantime, the PBOC set a firmer midpoint for the yuan today at 6.5593 per dollar versus 6.5618 per dollar on Tuesday. The yuan strengthened to 6.5660 per dollar earlier in onshore trading to later settle around 6.57 per dollar, before strengthening again to 6.5644 per dollar. It looks set to end the week little changed. Chinese markets will be closed on Thursday and Friday for the Dragon Boat Festival celebrations.

    The yuan appreciated by about 2% against the dollar between January and March but has since given up its gains as the dollar has rebounded. It touched a 5-month low of 6.5941 per dollar on June 1 as Fed rate hike expectations intensified but has since recovered slightly as the dollar as pulled back. Data out today showed China’s foreign currency reserves fell to the lowest since December 2011 in May, amid signs that the PBOC continues to intervene heavily to support the currency.

    However, markets appear less fearful of a gradual depreciation of the yuan as the increased volatility of the Chinese currency is in line with the PBOC’s new market-orientated approach of how it sets the midpoint. Since March, the PBOC has been closely following the yuan’s performance against a basket of currencies in setting the daily fix.

    The US also appears pleased with the progress China is making in reforming its exchange rate policy.  US Treasury Secretary Jack Lew said on Sunday that China is moving in the right direction regarding its currency but was more critical on how well the PBOC communicates its policies. China is keen to win the approval of US authorities as it seeks to internationalise the yuan. On Tuesday, Chinese and US authorities announced a program that will allow US funds to raise up to 250 billion yuan in investment quota to invest in Chinese securities.

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