The excitement surrounding the new Chinese yuan currency regime has been not been reflected in the non-deliverable forward (NDF) market.

The 1-year CNY NDF is only pricing in a 2 percent move in the next 12 months. This is conservative compared to the pricing of the 1-year NDFs in July 2005 when China altered their currency policy from a de-facto peg of 8.2765 yuan per dollar to a managed float.

At that time, the market priced in a 5.0 to 5.5 percent CNY appreciation. Recent quotes are less than half average appreciation of the 2005-2008 timeframe and much less than senior politicians in the United States are seeking.

However, the market has reasons to be wary as the Chinese central bank (PBOC) proved that they will continue to buy dollars to stem the rate of appreciation only a day after releasing the renminbi from the peg.

Trading in NDF, forward contracts in which parties settle the difference between a contracted price and spot price, will be difficult for short term speculators. But they should not prove too burdensome for long-term investors and hedgers.

In early to mid-2005, when China last let go of a currency peg, the market estimated a 5 percent move on average. This proved to be a stronger move than the central bank would allow.

In the first year, the Chinese central bank maneuvered an appreciation of 3.5 percent, moving very slowly after the initial 2 percent drop. It took a couple of months for currency traders to adjust and get in synch with the officials in Beijing.

Unfortunately, the comfort level did not last long as the PBOC varied the rate and timing of yuan appreciation in an attempt to foil free riders.

A chart of the weekly and monthly changes in USDCNY show that the central bank would rarely let the yuan appreciate in successive periods, and made great efforts to shake out weak, short-dollar/long-yuan positions.

They were able to keep the market off-balance and behind the market. There was only one period of time where the 1-year USDCNY trades came within 1 percent of the actual rate at the time the non-deliverable forwards fixed.

Even though the PBOC kept the market guessing, they still managed to strengthen the yuan considerably and may do so again.

From mid-July 2005 to mid-July 2008, the central bank allowed the renminbi to appreciate 17.5 percent, or roughly 5.8 percent per annum over the three years.

The initial market expectation was much closer to the eventual rate than they realized. In the first year, the central bank increased the rate of appreciation from 2 percent to 3.5 percent.

In the second year the rate of appreciation fell to 1.5 percent initially and then accelerated to 5.2 percent. During the third year the central bank relaxed their hold on the dollar and allowed the rate of yuan appreciation rise from 5.2 percent to a high of 9.85 percent.

The question is whether they will follow a similar path in the coming years.

Every major trading partner was disgruntled with the peg of the past two years. Even though China had let the yuan appreciate 17.5 percent between 2005 and 2008 from 8.2765 to 6.8250, after two years of immobility the Peterson Institute reckons that the renminbi is 24 percent undervalued. For details see

In 2005, like now, the market and politicians started crying for a revaluation long before the actual event. If the pace of reform is slow, Senators Charles Schumer of New York, Debbie Stabenow of Michigan and Lindsey Graham of South Carolina will resume their attack by passing a bill that will raise trade barriers for currencies (i.e., the Chinese yuan) that continue to be fundamentally misaligned.

The threat of congressional action helped in 2005, it may be enough to compel the People's Bank of China to allow the currency to appreciate more than 2.5 percent in the next twelve months.

(Editing by Andrew Hay)