Yuan ends 2010 with a flourish, up 3.6 percent on year

China's yuan ended 2010 on a strong note, pushing past 6.59 per dollar on Friday to close the year up 3.6 percent and fanning hopes that it will see even more gains next year.

The currency closed at 6.5897 per dollar, capping nine trading days that saw it rise 1.3 percent from a recent low and giving a decisive close to the year after the currency zig-zagged from mid-October to mid-December.

The yuan's strength came after the People's Bank of China (PBOC) set its mid-point at a record high for the second straight day, signaling the central bank may be engineering a fresh leg of yuan appreciation ahead of the visit by Chinese President Hu Jintao to the United States in mid-January.

But the central bank also sent a signal that coming rises in the yuan would not be drastic, as the fixing was just two pips higher than Thursday's.

China-based traders expect the yuan to rise about 2 percent in the first quarter of 2011. For all of next year, it could gain around 6 percent as Beijing uses currency appreciation as a tool to fight consumer inflation, which hit a 28-month high in November, they said.

"There will be no linear appreciation, but zig-zags," said

a senior trader at a U.S. bank in Shanghai. "But overall, you can still see significant rises by the end of certain periods, with opportunities open for those who have good understanding of the complicated Chinese currency system."

One of those opportunities could be in the first two weeks of the year, ahead of President Hu's U.S. visit, some traders say.

While the Chinese government generally tries to paint a picture of resisting U.S. pressure for yuan appreciation, in reality it often lets the currency strengthen ahead of major political events in recognition of the importance of the ties between the world's two biggest economies.

Record High

Dealers said offshore forwards, which imply yuan appreciation of less than 1 percent against the dollar in three months, are underestimating the yuan's potential and so present a window to short dollars in contracts out to one year.

Three-month one-year non-deliverable dollar/yuan forwards (NDFs) fell to 6.5657 in late trade from Thursday's 6.5670, implying yuan appreciation in three months' time of 0.87 percent. That's up from 0.85 percent but lags by far the 2 percent rise foreseen by onshore traders in the first quarter.

Benchmark one-year NDFs were bid at 6.4318 from Thursday's close of 6.4508. Implied yuan appreciation in a year's time rose to 2.97 percent from 2.66 percent.

"I think the NDF market is going short USD into the New Year, with more confidence in Hu's visit to Washington in January," said a trader in Singapore.

"That is also part of the factor in causing other USD/Asia to head lower. One-year USD/CNY NDFs could move toward 6.41 when Hu visits the U.S.," he said, adding the tenor was lagging now because many traders were on holiday.

Woon Khien Chia, a strategist at The Royal Bank of Scotland in Singapore, said: "My suspicion is that some of the recent changes, the latest being the curbs on net open CNY positions in Hong Kong banks, might have curtailed NDF activities."

Still, the PBOC appears reluctant to let the yuan rise too fast because of the threat of speculative capital inflows seeking returns on higher interest rates and expectations of yuan appreciation, traders said.

China has seen a steady increase of fund inflows in the last decade. The latest central bank data showed capital inflows slowed in November from a near record high in October but were still at a relatively high level.

[Source: By Lu Jianxin and Jason Subler, Reuters, Shanghai, 31Dec10]

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