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HONG KONG, Jan 9 (Reuters) - The Chinese yuan stabilized in offshore markets on Monday and its borrowing costs retreated from record highs, though investors anticipated Beijing would take further steps to stop its currency from depreciating too quickly.
In recent weeks, Beijing has resorted to interventionist tactics in both onshore and overseas currency markets by selling dollars aggressively, and by strengthening measures to slow capital outflows from China.
By afternoon trade, the offshore yuan (CNH) was trading at 6.888 per dollar, slightly weaker than Friday's close of 6.8490, in a sign that Beijing was letting market forces dictate the direction of the yuan in Hong Kong so long as the pace of depreciation remains within Beijing's comfort zone.
Some dealers still expected more sharp movements to come.
"Despite some semblance of order emerging, we should expect volatility to remain high," warned Stephen Innes, senior trader at FX broker OANDA in Singapore, in a note.
"Underlying yuan depreciation pressures should return as fundamental reasons that are driving depreciation, such as capital outflows and concerns on Trump's China policies, haven't changed."
U.S. President-elect Donald Trump's protectionist policies especially with relation to global trade and his tough stance on Chinese companies doing business in the United States have raised concerns among global investors that Beijing may pursue retaliatory policies. China had been the biggest buyer of U.S. debt until October, when it was overtaken by Japan.
On Monday morning, overnight yuan deposit rates fell to around 10 percent from Friday's high of 87 percent. Chinese monetary authorities had induced a spike in interbank rates for the offshore yuan last week that made it prohibitively expensive to short the Chinese currency.
As the short-sellers rushed to cover, the offshore yuan jumped 1.8 percent last week, its biggest weekly rise on record, according to Thomson Reuters data.
But broader concerns have not gone away. Data released on Saturday showed China's foreign exchange reserves fell for a sixth consecutive month, hitting near six-year lows of $3.011 trillion by the end of December.
"If intervention does not appear sustainable, a currency crisis will erupt well before reserves are exhausted," Mark Williams, chief China economist at Capital Economics in London, said in a note.
On Monday, some of those funding pressures showed signs of easing with the CNH Hong Kong Interbank Offered Rate benchmark (CNH HIBOR), down to 14.05 percent compared to 61.33 percent on Friday.
Last week's jump in overnight rates was caused by a sudden withdrawal of Chinese banks - traditionally the biggest lenders of overnight money - from the offshore yuan money markets. Speculators, who borrowed funds in these markets to bet against the yuan, had to scramble to cover their positions.
The People's Bank of China (PBOC) had created a CNH shortage in the offshore market, the head of local FX trading at a European bank in Singapore which trades with Chinese state banks, said.
He said investors had mostly been long the U.S. dollar versus the yuan and other currencies at the end of last year.
"Given the year end dynamics, the PBOC used the opportunity and created a big CNH shortage by asking Chinese banks to start offering term CNH liquidity at higher rates.
"Spot CNH liquidity is anyway tight due to a falling deposit base. That has created a massive shortage and CNH is likely to be supported unless the situation normalizes," he said.
Despite the sharp drop in HIBOR rates, market watchers believe the funding costs are likely to stay elevated ahead of the Chinese New Year break at the end of the month.
Additional reporting by Michelle Chen and Winni Zhou in SHANGHAI; Editing by Simon Cameron-Moore