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Ahead of the much-anticipated U.S. rate hike this week, the People's Bank of China said it would manage its yuan to track a currency basket rather than its long-held stance of pegging to the dollar.

The PBoC will follow a wide range of currencies such as the dollar (26.4%), euro (21.4%), the Japanese yen (14.7%), the Hong Kong dollar (6.6%), the Australian dollar (6.3%) and other commodities currencies such as the Malaysian ringgit, the Russian ruble and the Canadian dollar. The U.S. dollar still is the heavyweight, with one-third stake since the Hong Kong dollar is pegged to the U.S. dollar.

So is this a cover for more yuan devaluation? You may argue the yuan is too expensive. Based on this currency basket, the yuan has appreciated 2.9% since the end of 2014, while it fell 3% against the U.S. dollar.

I have three broker reports with me assuring us this is not another surprise attack from the PBoC.

The PBoC is just taking care of its own monetary policies. "It would be most advisable for the PBOC to continue loosening the de facto RMB peg with the USD in order to be able - in an ever more open capital account - to conduct a monetary policy independent of US policy and responsive first and foremost to China's economic requirements," noted ReOrient Research's Uwe Parpart. It makes sense, because since China is cutting rates, it has to let its currency go especially if the U.S. is walking the other way. ReOrient sees the yuan to fall to 6.8 by the end of next year, reflecting a gradual unwinding of the stronger yuan against the currency basket.

Capital Economics' Mark Williams said "as long as the trade-weighted rate is stable, we shouldn’t characterise this as depreciation." The research firm also sees the yuan to fall to 6.8 by the end of 2016 before recovering to 6.5 in 2017.

Morgan Stanley's Chetan Ahya shrugged away the announcement, saying it was no news. "Based on initial comments from the policy makers in the media in the context of the policy shift on August 11, we have been highlighting that since the PBOC moved towards aiming for a stable trade-weighted RMB instead of stable USDCNY exchange rate." The bank also sees 6.8 by 2016 year-end.

The PBoC statement was released after Asia market hours but before U.S. open. The response was fairly muted. The JPM Emerging Market FX Index fell 1.1%, driven by commodities currencies. The Russian ruble dropped 3.2%, the Mexican peso fell 4.2% and the Brazilian real was down 1.5%. Oil fell for a 6th day, down over 10% for the week. On Friday, the iShares China Large-Cap ETF (FXI) fell 2.8%, the iShares MSCI Emerging Markets ETF (EEM) dropped 2.8%, the iShares Emerging Markets Local Currency Bond ETF (LEMB) was down 1.4%. The Powershares DB US Dollar Index Bullish Fund (UUP) fell 0.4%.

UPDATE:

Last month, yuan bear Bank of America Merrill Lynch wisely warned us that China would "devalue yuan" soon after IMF's SDR inclusion. We should have listened!

This morning, the bank had a note out disagreeing with its peers, saying that PBoC's announcement spells more trouble ahead:

Under this event, we believe the central bank would choose to allow exchange rate adjustments to take place through a faster slide against the dollar by reducing support from FX intervention. In the context of the small devaluation on August 11th and the NEER index emphasis, the hurdle for

another one-off reval is higher than before.

See also my November 23 blog "Merrill: Short Yuan Is Our Favorite 2016 FX Trade".

Now Merrill is warning us of spillover effects. The Bloomberg Asia FX Index closed at 106.36 on Friday, breaking the trend support line of 106.52, in place since 1998.

In particular, we need to watch closely what happens to the Korean won, the Taiwan dollar and the Malaysian ringgit. In its currency basket, the PBoC gives the ringgit a prominent 4.7% weight.

This morning, the PBoC guided its yuan fix rate lower for the sixth day, to 6.4495 versus last Friday’s 6.4358, the lowest since July, 2011. The onshore yuan fell 0.5% to 6.48 and the offshore yuan dropped 0.2% to 6.5474.

Other emerging Asian currencies fell too. The ringgit was down 0.7%, the Korean won fell 0.7% and the new Taiwan dollar was off 0.3%.

UPDATE 2: Apologies for all the updates... The currency markets are moving much faster than I can type. The yuan's losses narrowed. The CFETS RMB Index is calculated at 101.45 this morning (the base is 100, as of December 31, 2014). Markets are feeling slightly assured that the PBoC sees the yuan to be only 1.45% overvalued.