The yuan's recent depreciation has left many observers wondering what is going on. Since mid-2012 the yuan has generally traded near the top of the trading band partly because expectations of a one-way bet have boosted its demand. Speculative inflows are again an issue, if reports of dodgy export invoicing are true. The yuan has now fallen for six consecutive days, and since its high in January, it has fallen 1.4% against the dollar. Such a concerted decline strongly suggests that the government is trying to send the market a message.
Financial conditions in China have improved greatly over the past few months. Interbank borrowing costs, as seen in the Shibor, have fallen as the People's Bank of China has maintained adequate liquidity in the market. The spread between one-year and 10-year government bonds has widened, suggesting confidence that economic growth and interest rates will rise in the future.
This may have provided the PBoC the opportunity to remind the market to expect 'reasonable' volatility in financial markets. Yet despite the recent depreciation, markets do not seem convinced that it will last. Yuan forwards have actually risen over the past few days, suggesting that markets believe the yuan will more than make up its losses over the past few days.
Alaistair Chan is an Economist at Moody's Analytics.
More from Dismal Scientist: