LONDON The global gloom over China's yuan has deepened swiftly, with investment banks slashing forecasts and some analysts and money managers arguing it should fall by 15 percent or more to respond to Beijing's financial imbalances.
It is still a daring bet, and not just because of China's more than $3 trillion in currency reserves. Beijing demonstrated the tools it has at its disposal to fight a currency rout this week by jacking up interest rates for yuan held off shore.
Nevertheless, with some global banks forecasting the yuan moving above 7 per dollar, hedge funds are contemplating the prospect of a far bigger shift.
It no longer even seems ridiculous to imagine the renminbi passing the other notable Chinese currency - the Hong Kong dollar - on its way down. The dollar, which trades in a tightly-controlled band at around 7.8 to its U.S. counterpart, has itself been caught in the yuan's downdraft, falling its fastest in 12 years on Wednesday, though still within its band.
"Maybe China goes to where the dollar-Hong Kong is. That's your first port of call – 7.78," said Chris Morrison, Head of Strategy and a portfolio manager at London-based Omni Partners' Macro Fund.
Morrison, who has been betting against the yuan since the start of 2014, argues that the world's second biggest economy has already left the era of controlled, minimal moves in its currency.
"Dollar-China had always been a very low volatility currency pair that has moved in very tight ranges. That is clearly changing. We're forecasting dollar China going from 6.50 to above 7, but you can get a more severe outcome."
Though few were willing to go public with firm predictions of such a sharp fall, more than 30 major market players Reuters spoke to in the past week in Europe and the United States said they would not rule out a further 15 percent depreciation of the yuan this year.
"Chinese investors are voting with their feet. Money is moving out on an individual, corporate and institutional basis," said Mike Newton, Chief Investment Officer for Equities at another hedge fund, The Cambridge Strategy, in New York.
"If they want to stabilise the currency the only way they can do it is to jack up rates or close the current account."
COMPARISONS TO EUROPE
Still, there are strong reasons not to bet against Beijing. This week's move to crush the availability of the yuan in Hong Kong saw overnight market interest rates pushed as high as 94 percent.
Such drastic measures remind some of the older heads in the market of the pre-euro battles between George Soros-led financial speculators and several major European countries, when investors humiliated governments and walked away rich.
Steven Englander, global head of FX strategy at the currency market's biggest banking player Citi, says China is in a much stronger position than European authorities were then, because it can differentiate between offshore and onshore interest rates.
"Intervention (then) failed because the ERM countries could not keep rates high enough for long enough to discourage speculation," he said in a note comparing the two this week.
"Provided that they can keep onshore rates much lower than offshore rates, they can intimidate speculators without doing the kind of damage the UK and Sweden were doing to their economies in 1993."
Even those predicting another sharp slide say the odds are that China's enormous reserve pile - $3.3 trillion at last count although that has almost certainly fallen sharply in January - will allow it to keep things relatively orderly.
"I do believe China will be able to stabilise this, the market is big but they are one of the biggest," said the head of global FX trading with another of the global currency market's big six banks, asking not to be named.
"If you look at where the currency was a decade ago, it was up around the 7 to 8 handle, before the era of 10 percent growth set in. We could go a lot further, there's a lot of pressure. It's going to be a buy on the dip sort of scenario for the next 3, 6, 9 months."
He and a number of other senior market makers and holders of corporate books on the yuan also say that underlying fund and corporate interest in the yuan has not been significantly squeezed by the PBOC's efforts since last week.
Several say big European exporters who receive yuan from Chinese customers have not even begun to sell their currency in the current move.
"They do need to be careful that the yuan does not move from being an investment currency to being a traded one, that it does not become a hedge fund's dream," said a senior trader with one Asian bank in London.
"Everyone I read now says 6.90, 7 but the world can do what it wants. This is not some small emerging economy, it's China. And they are going to have a tough battle."
(Editing by Peter Graff)
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