The official Purchasing Managers' Index (PMI) came in on Sunday at 49.8, missing the forecast of 50.2. The official PMI is derived from monthly surveys of large and state-owned companies. A PMI number below 50 indicates contraction in manufacturing activities.

The latest PMI data suggests that China’s economy is still contracting despite the recent rate cuts by the People's Bank of China (PBoC). Last November, the PBoC announced a cut in the one-year benchmark lending rate by 0.4%, to 5.6%, and in the one-year benchmark deposit rate by 0.25%, to 2.75%. The PBoC rate cuts, which are asymmetrical, meaning a cut in the lending rate is more than a cut in the deposit rate, have been criticized as short on impact.

Ahead of the China PMI report, the spread between the China renminbi (CNY) or Mainland yuan, and the Offshore yuan (CNH), surged to 3.62 bps on Friday as the U.S. dollar – CNY and – CNH exchange rates traded to an intraday high of 6.2520 yuan per dollar and 6.2882 yuan per dollar, respectively.

The Chinese currency has two different exchange rates, depending on whether it is traded in Mainland China or Offshore. A 3.62 bps spread between the two exchange rates could indicate that the forex traders were selling CNH, in antipication of a bad China PMI, and buying the U.S. dollar.

The U.S. Dollar index (DXY) surged to 94.921 on Friday, shy of the 52-week high of 95.527, despite the lower-than-expected fourth-quarter real GDP report. The U.S. Bureau of Economic Analysis (BEA) said on Friday that the advance estimate of real GDP in the fourth-quarter was 2.6%, well below the 3.2% forecasted by economists surveyed by The Wall Street Journal.

We think that the just-released official China PMI data could force the PBoC to announce more broad-based stimulus, more rate cuts as well as a cut to the banking industry's reserve requirement ratio, known as RRR.

China can’t do much to depreciate its currency in order to boost its exports, as the forex traders have already pushed the yuan close to the upper limit of its 2% trading band. Widening the daily trading band could be seen by the United States as currency manipulation, as the United States already warned Beijing last April about Chinese currency deprecitation.

The PBoC currently pegs the yuan to the U.S. dollar at about 6.125 yuan per dollar and lets it trade as much as 2% on either side of what is known as the parity rate.