China's Currency Regime Evolution: Fix Predictability, Dollar Impact, and Exchange Rate Dynamics

Exploring China's Evolving Currency Regime: The Fix, Dollar Movements, and Exchange Rate Dynamics

Abstract:

This study delves into the determinants of dly fluctuations in the value of the Chinese currency CNY since early 2016, a period marked by a transition to a new fixing mechanism for setting the midpoint of the CNY's trading range agnst the U.S. dollar. We demonstrate that the announced fix exhibits high predictability and responsiveness to overnight onshore market movements and changes in cross-rate dynamics. Despite its predictive capabilities, the impact of the fix on subsequent exchange rate behavior is uneven. Our analysis reveals that the CNY's dly volatility remns unusually low, yet shows a closer resemblance to freely floating currencies' behavior over time.

Introduction:

The evolving nature of China's managed float system has been a focal point in global financial dynamics since its reformation in 2016. This paper investigates how dly changes in the exchange value of the CNY are influenced by overnight events and broad movements in the U.S. dollar, alongside the role played by official intervention mechanisms.

:

We utilize empirical analysis to dissect the predictability and impact of the fixa critical component in determining the CNY's dly trading rangeand its influence on subsequent currency behavior. By examining historical data, we explore correlations with overnight changes in cross rates and the evolution of market expectations.

Findings:

1. High Predictability of Fix: The announced fixing mechanism is highly predictable, responding promptly to fluctuations during the previous day's onshore trading session as well as shifts in dollar cross rates.

2. Uneven Predictive Impact: While the fix is a significant driver for short-term exchange rate movements, its predictive efficacy varies over time, particularly in the context of intervention intensity.

3. Volatility Dynamics: The CNY displays unusually low dly volatility compared to freely floating currencies, with these dynamics evolving as the currency's behavior aligns more closely with those of freely floated assets.

Policy Implications:

As China's economy adjusts to a more market-driven currency regime, policymakers must navigate the balance between mntning stability and facilitating economic openness. The findings suggest that while intervention can smooth out short-term volatility, long-term strategy should focus on further integration into global financial markets.

:

China's managed float has evolved in response to economic realities and international pressures, with the fix becoming a pivotal tool for managing currency fluctuations. By incorporating insights from this study, policymakers could refine strategies to optimize the role of official intervention while allowing the CNY to reflect market forces more fully. This evolution underscores China's commitment to financial reforms and its integration into global economic systems.

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