The global capital markets are subdued as the week draws to a close. Asian stocks, while European bounces are heavier. Bonds are firm. The dollar itself is little changed against the major currencies.  

Chinese markets had been a source of global volatility, but they too are becalmed today. The large move on the offshore yuan yesterday has subsided. Although there was talk that the PBOC had directly intervened in the offshore market yesterday, confirmation remains elusive.  More likely, the presence of large state-owned banks buying the offshore yuan (CNH) yesterday was interpreted many as operating on behalf of officials.     

In order to “perfect” the new currency mechanism, two convergences are ultimately necessary. The first, as we have been emphasizing is the convergence between the daily reference rate (fix) and the spot market. This convergence has largely taken place. 

However, this convergence in the first instance spurred a divergence between the onshore and offshore yuan. The second convergence is really the re-convergence of the onshore and offshore yuan. The increased fungibility of CNY and CNH is important for hedging purposes, and is also operationally important for the easily accessible criteria of joining the SDR.   

Closing the gap between the two may also dampen the downside pressure on CNY. Many observers had seen the future of CNY in CNH, ie, the weakness in the offshore yuan was seen as a sign the need for a further decline in the onshore yuan. The spread between the two widened back slightly today, but we should think of it as a process. Market participant will likely this evolve in the coming days. 

Just like the run-up to EMU facilitated various reform efforts in Europe, the drive for SDR membership is encouraging reforms in China. When China was experiencing capital inflows, officials took steps in the direction of liberalizing outflows. Now that is experiencing outflows, it is finding was to liberalize inflows.

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