China's yuan takes breather, policymakers' steps seen as fostering near-term stability

China's yuan took a breather to trade steady on Tuesday after a sharp rally the previous session, with traders expecting few big moves in the currency ahead of the upcoming golden week holiday.

Statements from China's central bank warning against overshooting of the currency along with some nascent signs of economic stabilisation have raised traders' expectations for a more stable yuan over the near term.

Prior to the market's opening, the People's Bank of China (PBOC) set the midpoint rate USDCNY at 7.1986 per U.S. dollar, 162 pips firmer than the previous fix 7.2148 and 873 pips firmer than Reuters' estimate.

Market participants took Tuesday's fixing in their stride after PBOC set the midpoint guidance with the strongest bias on record on Monday and issued statements to fend off risks of the yuan overshooting.

The actual fix level below 7.20-level provides consistent messaging that policymakers will not withstand an excessive overshoot, strategists at OCBC said.

Beijing may want to keep the yuan stable into the golden week holiday in early October, said Philip Wee, senior FX strategist at DBS, adding that policymakers still need to restore confidence in its economy.

Spot yuan USDCNY opened at 7.2900 per dollar and was changing hands at 7.2875 at midday, little moved from the previous late session close.

The offshore yuan USDCNH was trading 153 pips weaker than the onshore spot at 7.3028 per dollar.

"As the desk has highlighted a few times in recent weeks, spot (offshore yuan) remains challenging to trade with continued smoothening, funding squeezes, policy comments and actions," UBS analysts wrote in a note.

The offshore yuan liquidity has remained tight with Hong Kong's overnight yuan borrowing costs at elevated levels, making it costly to short the Chinese currency.

The overnight CNH Hong Kong Interbank Offered Rate benchmark (CNH HIBOR) (HICNHONDF=) rose 51 basis points to 4.44303% on Tuesday, the highest since April 2022.

Sources told Reuters on Monday that China's central bank is tightening its scrutiny of bulk dollar purchases by domestic firms, at a time when the Chinese currency faces mounting depreciation pressure.

The yuan market at 0306 GMT:

ONSHORE SPOT:

Key indexes:

*Divergence of the dollar/yuan exchange rate. Negative number indicates that spot yuan is trading stronger than the midpoint. The People's Bank of China (PBOC) allows the exchange rate to rise or fall 2% from official midpoint rate it sets each morning.

OFFSHORE CNH MARKET

*Premium for offshore spot over onshore USDCNY

**Figure reflects difference from PBOC's official midpoint, since non-deliverable forwards are settled against the midpoint. USDCNY.