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The news of the day is obviously the Chinese move to de-peg the Yuan fro the dollar.  The following are some thoughts from Goldman Sachs on the change:

“The People’s Bank of China (PBOC) announced on June 19 that China will further reform the exchange rate regime and enhance the CNY exchange rate’s flexibility.  The announcement confirmed the daily trading band around the central parity that the CNY trades against the USD will be kept unchanged at +/-0.5%, but did not mention any one-off change in the spot USD/CNY rate.

We believe this is a positive gesture, which suggests:

1) The appreciation of the CNY to resume without a sizable one-off change initially…The announcement made it clear that the current peg of the CNY against the USD since September 2008 will be removed and the CNY will soon resume its appreciation against the USD, although the probability of a sizeable one-off change on June 21 has become more limited.

2) A return to the crawling peg against the USD…While the central bank stated it will reintroduce the emphasis of “reflecting market supply and demand with reference to a basket of currencies” in the CNY exchange rate, we believe the most likely scenario is for the CNY to return to a crawling peg against the USD, resembling the exchange rate regime during 2005-2008, at least initially. In our view, the appreciation will likely take place through downward movements in central parity rates as well as during intra-day trading. It is supportive to our trade recommendation of shorting the USD/CNY 1-year NDF (target 6.50) made on June 10, 2010.

The move is consistent with our expectation that the Chinese government will allow more flexibility in the CNY exchange rate through gradual moves.  We have long held the view that de-pegging from the USD and moving to a more flexible exchange rate regime is the right thing for the Chinese government to do, not the least because of the foreseeable trade protectionist pressures. Therefore, while we adjusted our exchange rate forecasts of the AEJ currencies on June 10 to incorporate our new EUR/USD forecasts, we have kept our 3, 6, and 12-month USD/CNY exchange rate forecasts unchanged at 6.74, 6.66, 6.49. In addition, the likely absence of a sizeable one-off change in the spot exchange rate is consistent with our expectations that Chinese government officials prefer to use a risk-based gradualist approach in policy reforms.

This policy change demonstrates that the Chinese government has become more confident of the global recovery and more proactive in managing the risk of trade protectionism and global demand rebalancing. As the PBOC governor Zhou Xiaochuan mentioned previously and stated again in the announcement on June 19, the reform of the CNY exchange rate regime will resume after the crisis period. In our view, the timing chosen by the decision makers in the Chinese government also reflects their determination to pre-empt further protectionist threats as well as efforts in rebalancing the growth driver towards domestic demand.”

Source: GS

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