China’s central bank has instructed domestic lenders to reduce their outward bond investments in an effort to support the yuan, according to sources familiar with the matter. The directive specifically targets southbound purchases under the Bond Connect scheme, with the aim of limiting the supply of yuan offshore. The sources spoke anonymously, and the People’s Bank of China (PBOC) declined to comment on the guidance.
This move is part of a broader strategy to make it more difficult to short the yuan and to stabilize the currency against the US dollar. As China’s financial markets experience losses and capital outflows, policymakers are taking stronger measures to address these challenges and stabilize the economy. The weakness of the currency highlights the difficulties Beijing faces in reviving economic growth without exacerbating depreciation pressure and capital outflows.
The guidance from the PBOC is expected to reduce capital outflows through the bond market and increase offshore yuan yields to support the renminbi. The yuan has depreciated by over 5% against the US dollar this year, reaching a 10-month low last week. While it has since stabilized, the spread between onshore and offshore forwards has widened, indicating increased costs for offshore short sellers.
The central bank’s request to scale back outward bond investments under the Bond Connect scheme could have a significant impact, as mainland institutional investors currently hold around 426.98 billion yuan ($60 billion) in offshore bonds. Although it is unclear whether the request applies to banks’ own investments or those held on behalf of clients, the decline in total holdings in July suggests a response to previous efforts to discourage short selling.
In addition to the guidance on bond investments, the PBOC has also been urging banks to stop subscribing to Negotiable Certificates of Deposit (NCDs) issued by offshore banks. This is another step aimed at reducing offshore yuan trade and tightening offshore yuan liquidity. The central bank’s actions are seen as a warning to foreign yuan bears and have helped stabilize the currency.
To further support the yuan, the PBOC has been setting the trading band above market expectations and state banks have been buying yuan in both onshore and offshore foreign exchange markets. China’s major state-owned banks have also been drawing down offshore yuan liquidity in London and New York, leading to a sudden rise in yuan forwards.
Overall, these measures reflect the urgency with which policymakers view the stabilization of the yuan. By limiting outward bond investments and discouraging short selling, the central bank aims to support the currency and address the challenges facing China’s financial markets.
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