If the outsized moves in the Chinese yuan this week were anything to go by, China is taking a significant step toward achieving its dream of becoming a global financial center by 2020.

By breaking the yuan's peg to the dollar this week, China injected lifeblood into its nascent financial markets by introducing currency volatility, a must-have for speculators eager to punt on the yuan.

At a time when China's newest yuan regime is still shrouded in mystery, some analysts and traders said the surest aspect for now seemed to be that greater yuan volatility is here to stay.

For a currency that has spent its life under the thumb of the central bank, this is a pivotal turn that may hasten other much-needed development in China's financial markets, they said.

More two-way movement in the yuan would deepen Shanghai's currency market by raising liquidity and widening spreads, analysts said. China has opposed to speculators playing on the yuan but a deeper market would benefit businesses over long term.

Offshore forwards would also start betting on a weaker yuan, something they rarely done before.

In the eyes of some, the world's No. 3 economy cannot sell itself as a global financial center unless the yuan trades freely around the world -- Beijing's ultimate goal.

Yes, definitely, this week's events are a small step in that direction, said Khiem Do, head of the Asia multi-asset group at Baring Asset Management, which oversees $50 billion.

To become a financial center you need to have a very liquid and freely accessible financial market. Anything to encourage more flexibility is a very good thing.

For now however, implied volatility in the yuan has yet to budge to reflect the chance of bigger future gyrations. That led analysts at UBS and Westpac to say that yuan implied volatility is a bargain at present levels.

Westpac predicted one-year yuan implied volatility could rise to 6.0 percent in coming weeks, up from Wednesday's 4.50. UBS forecast the same contract to rise to an average 5.5 percent.

To me, I think it is cheap and the risks of volatility beginning to rise are quite high, said Robert Rennie, the chief currency strategist at Westpac in Sydney.

On the other hand, analysts said investors need to change tack when trading dollar/yuan non-deliverable forwards (NDFs) in future.

Rather than assume as in the past that the yuan would only rise on the dollar, investors need to note that higher volatility means the yuan can drop too, especially in the near term.

This means that NDFs can trade at a premium to the yuan's last traded price, a rarity in the past. NDFs bet that a currency would rise when they trade at a discount, and vice versa.

For now, investors still seemed fixated on a stronger yuan.

Robert Reilly, Asia co-head of flow fixed income and currencies at Societe Generale in Hong Kong, said volumes in NDFs spiked 40 percent in the past week on gyrations in the yuan.

He said investors were still more keen to sell dollar/yuan NDFs, especially one- to three-month tenor contracts.

Three-month NDFs on Wednesday were priced for the yuan to rise 0.7 percent over that period from the day's mid-point. One-year NDFs were priced for a 2.2 percent rise. Most analysts said these were reasonable bets.


For the last two years, China had chained the yuan, also known as the renminbi, to the dollar via a peg.

That drew ire from the United States, which accused China of unfairly suppressing the yuan to get an edge in trade.

So far, China is sticking to its vow to allow the yuan to trade more flexibly. The central bank stood aside to let the yuan rally 0.42 percent on Monday. The currency gave up some of those gains on Tuesday to drop 0.23 percent.

Those moves were hardly head turners by the standards of free-floating currencies but for the yuan, which often moved less than 0.3 percent in a day because of its peg, they were huge.

Indeed Monday's rise was its biggest in any day since the 2005 landmark revaluation.

To be sure, even with the latest shift, the yuan is still only permitted by China's central bank to rise or fall no more than 0.5 percent against the dollar on a given day from a reference rate set by the central bank.

But if China makes good its vow to let the market push the yuan about within that band it is a step up for the yuan.

Combined with China's move earlier this month to allow more cross-border trade to be settled in the yuan, many think the yuan market in Shanghai has a real chance of picking up.

Since the weekend announcement, Societe Generale's Reilly said more investors have been approaching his bank in Shanghai to ask how they can trade the yuan or hedge against its moves.

In the long run, hopes for a more volatile yuan should tempt more hedge funds to dive into yuan trades, he said.

Yuan currency traders in Shanghai agreed.

In the past, the market was always dead as usual, one said. Now, at the very least, our customers see the yuan moving about. That would encourage speculators and help trading volumes.

(Editing by Kazunori Takada)