Some of the biggest gains on record for China's yuan sent currency markets spinning on Thursday, driving the dollar broadly lower and threatening to quash one of the central bets of global investors for 2017.
A rise in overnight borrowing costs in Hong Kong to 96 % helped the yuan rack up the biggest two-day rise for the offshore version of its currency since its launch in 2010.
That in turn triggered a broader round of profit-taking on the dollar, sending it more than 1 % lower against the yen and as low as $1.0575 per euro before a late-morning recovery in Europe.
A year after a tussle between Beijing and hedge funds betting against the currency, many major asset managers and banks have called for the yuan to fall in 2017. Dealers said the moves had the potential to squeeze many players out of those positions just five days into January.
By midday in Europe, the yuan was just under half a percent higher on the day against the dollar at 6.8364, having gained almost 3 % from lows hit on Tuesday.
"They have kick-started a move that has washed out short-term speculative money," currency fund Millennium Global's co-head of portfolio management, Richard Benson, said.
"This isn't economics. China desperately doesn't want a repeat of what happened this time last year (and it seems) attack is the best part of defense."
Many banks and investors have also lined up bets on a broadly stronger dollar in the year ahead, trusting that a Donald Trump White House will raise public spending, spur inflation and encourage repatriation of corporate funds held abroad.
But the dollar's failure to move closer to parity with the euro, or to 120 yen, since mid-December has fueled doubts about its ability to gain further, at least before Trump's inauguration.
"The Trump bears kept quiet in December because there was no point in fighting the battle then. They seem to be emerging now," Benson said. "It is not just against the yuan. It looks to me highly suspicious that dollar can't get below $1.0375 (per euro)."
The dollar's index against a basket of six major currencies slipped to as low as 101.86, a three-week low, just two days after it had hit a 14-year high of 103.82 on Tuesday, when a strong reading from a U.S. manufacturing survey boosted the greenback. It was a third of a % lower on the day at 102.33 by 1220 GMT (7:20 a.m. ET).
The euro rose as much as 0.7 % in Asia to $1.0563 before trimming those gains to 0.2 %. The dollar still 0.6 % weaker at 116.61 yen.
"Tighter (Chinese) capital controls are a stop-gap measure that may plug one hole but won't prevent another one emerging elsewhere. Further ... weakness seems inevitable to us," said Societe Generale analyst Kit Juckes.
"However, challenging the market narrative that has seen investors and traders pile into the dollar since early November is enough to trigger a sharp cutback of longs, not just in the U.S. dollar/Chinese Renminbi (USD/CNH) currency pair but across G10 currencies."