China's yuan eases against US dollar, dragged by narrowing yield advantage

China's yuan eased against the dollar on its first trading day of 2022, after posting full-year gains for two straight years, with investors worried that a shrinking yield gap between the world's two largest economies could trigger capital outflows.

The yield spread between Chinese and U.S. 10-year government bonds fell to its narrowest since mid-2019 early on Tuesday, with Treasury yields buoyed by expectations of possible U.S. rate hikes this year.

Prior to the market opening, the People's Bank of China (PBOC) set the midpoint rate at a two-week low of 6.3794 per dollar, 37 pips weaker than the previous fix 6.3757.

In the spot market, the onshore yuan opened at 6.3696 per dollar and was changing hands at 6.3721 at midday, 171 pips weaker than the previous late session close.

Several traders said companies continued to convert their dollars into yuans early on Tuesday, despite the narrowing yield advantage, limiting the downside for the local currency.

The Chinese yuan ended 2021 2.7% higher against a strengthening dollar, supported by robust exports, a growing trade surplus, and steady capital inflows into Chinese assets.

"Trade and interest differential will continue to be key factors driving CNY FX rates in 2022, however, they are likely to provide less support for CNY," Lin Li, head of global markets research for Asia at MUFG Bank, said in a note.

"Exports growth is set to decline, and the divergent monetary policies between China and United States means that the interest rate spreads (will) likely narrow, as (the) PBOC continues to loosen its policy while (the) Fed hikes its policy rate possibly three times."

China cut its lending benchmark loan prime rate (LPR) for the first time in 20 months at its December fixing, with market participants widely expecting the PBOC to ease further to cushion an economic slowdown.

Separately, traders said the impact from the China Foreign Exchange Trade System's (CFETS) decision to raise the dollar and the euro's weightings in its key yuan basket index were limited.

The CFETS index stood at 102.56 on Tuesday, after rising 8.05% to 102.47 in 2021.

By midday, the global dollar index was up at 96.265 from a previous close of 96.213, while the offshore yuan was trading at 6.3731 per dollar.

The yuan market at 0400 GMT:

ONSHORE SPOT:

Item Current Previous Change PBOC midpoint 6.3794 6.3757 -0.06%

Spot yuan 6.3721 6.355 -0.27%

Divergence from -0.11%

midpoint*

Spot change YTD -0.27% Spot change since 2005 29.89% revaluation

Key indexes:

Item Current Previous Change

Thomson 102.32 102.31 0.0 Reuters/HKEX

CNH index

Dollar index 96.265 96.213 0.1

*Divergence of the dollar/yuan exchange rate. Negative number indicates that spot yuan is trading stronger than the midpoint.

The People's Bank of China (PBOC) allows the exchange rate to rise or fall 2 percent from official midpoint rate it sets each morning.

OFFSHORE CNH MARKET

Instrument Current Difference from onshore Offshore spot yuan 6.3731 -0.02%

*

Offshore 6.5231 -2.20%

non-deliverable

forwards

**

*Premium for offshore spot over onshore

**Figure reflects difference from PBOC's official midpoint, since non-deliverable forwards are settled against the midpoint.

.

(Reporting by Winni Zhou and Andrew Galbraith; Editing by Ana Nicolaci da Costa)