The effects of China's rules-change proposals around the Yuan Fix are already starting to show in the FX, money markets as one-week funding costs have exploded to the annualized equivalent of 14%...

As a reminder, we reported late last week that China announced it would introduce a new "counter-cyclical factor" to reduce exchange-rate volatility while undermining efforts to increase the role of market forces. In some ways this announcement was not unexpected: recall that after a period of eerie stability, on Thursday the Yuan surged shortly after China's downgrade by Moody's, which prompted speculation that the central bank was directly manipulating the currency as the PBOC’s daily fixings had "materially diverged" from the prescribed formula, resulting in a gap between the reference rate and currency’s spot value.

Roughly at the same time as a similar move was taking place on Friday, Bloomberg first reported and China later confirmed that policy makers would add a “counter-cyclical factor” to the yuan’s daily fixing, a move which "would give authorities more control over the fixing and restrain the influence of market pricing." Subsequent detailed revealed that authorities would change the daily $/CNY fixing mechanism, so that the change of the fixing from the previous day’s close would also take into account a “counter-cyclical adjustment factor” (how this is determined is not specified though), in addition to the USD’s movement against a basket of currencies.

While the practical consequence was a surge in both the onshore and offshore Yuan to three month highs, traders and commentators were left confused by this latest intervention by Beijing into what has become China's fulcrum security.

“The counter-cyclical adjustment factor sounds like an increased role for the fixing to be nudged away from where markets would set it,” Sean Callow of Westpac Banking Corp told Bloomberg. “The authorities’ actions give the impression that they are more worried about yuan stability than declared in their public statements.”

The reaction has been notable...

Offshore Yuan has spiked dramatically in the last few days - coinciding with apparent Fed dovishness in the minutes and PBOC rule changes...

And, as Bloomberg details, deliverable yuan funding costs have soared after the PBOC said it’s considering changing the way it calculates the yuan daily reference rate. One-week forward points have more than doubled to the equivalent of about a 14 percent annualized interest rate.

Though traders anticipate that funding costs will retreat after month-end, a policy shift may keep markets on edge -- on two previous occasions the PBOC adjusted its fixing mechanism, in 2015 and earlier in 2017, costs remained elevated for weeks.