The yuan continued to advance against the dollar as traders saw the reference rate as an encouraging sign for more flexibility in the underlying spot. Against the US dollar, the yuan traded higher at 7.5500 in New York, while dropping against the Euro (10.29) and the British Pound (15.19). In addition to the daily fix, the underlying yuan traded towards the highest since the 2005 revaluation, gaining for the fifth day, on the heels of comments by the PBoC deputy governor (see below). Citing inflationary pressures, the comments helped to spark further speculation of near term changes to the trading band as the country’s consumer prices continue to skyrocket. Notably, China stocks fell for the first time in seven sessions as investors saw recent prices as being overextended. Metal producers helped to lead decliners with bellwethers Baoshan Iron & Steel Co. and Jiangxi Copper declining on the day. The CSI 300 benchmark index closed down 79.95 points or 1.5 percent off at 5,171.82.

China Sells Bonds For Reserve Fund, First Step For Investment Agency
In the first steps towards establishing an investment fund, China’s government sold 600 billion yuan in bonds to help fund the agency that will help in investing the country’s massive reserves. The Ministry of Finance sold benchmark 10-years to the central bank in working towards a $200 billion investment company that is hoping to add returns to $1.33 trillion in current reserves. In a statement by the Ministry, the sales was aimed at helping to “reduce the size of foreign exchange reserves and improve returns.” Subsequently, longer termed maturities, which are expected in future transactions, will “diversify bond types and the duration structure.” On completion of the fund, the agency’s holdings will outpace Temasek Holdings Pte, which has $107 billion under management.

Deputy Governor Comments On Measures To Combat Inflation
The People’s Bank of China Deputy Governor Su Ning today cited that policy makers are effectively monitoring the current pace of inflation, looking to “actively” take measures to curb further acceleration. The comments, although strongly worded, may not produce as much of an effect as previous tightening measures have, for the most part, been thrown to the wayside. With the country’s current rate of inflation running at a 10-year high of 5.6 percent, the central bank has raised interest rates four times in first half of the year. Deputy Su confirmed the concern saying that “based on analysis of current data, the full year consumer price index may still rise to more than 3 percent even if we step up micro-economic control measures for the rest of this year”. As a result, the only effective option would be to revalue the currency, helping it to appreciate in line with market expectations. The notion helped to boost the underlying yuan in the overnight session as traders continue to hope for the best.

Asian Markets Tumble On More Subprime Concerns
Following equity market action in the US, regional Asian markets took a turn for the worse with both Singapore and Hong Kong markets closing lower. Hong Kong stocks fell the most in two weeks as US subprime concerns, lower consumer confidence and profit taking hit the Hang Seng in the overnight session. After it was all said and done, the benchmark index closed lower by 343.16 points or 1.5 percent at 23,020.60. Leading decliners were interests in HSBC, which generated almost a third of its revenue from North America last year. The stock dipped by HK$1.60 to HK$138.20. Singapore shares fared slightly better as the index dropped 8.34 points to close down 0.3 percent at 3,334.66.

Richard Lee is a Currency Strategist at FXCM.