The extremely popular yen carry trade crashed and burned this month when the Japanese currency rose. A lesser-known version of this strategy could also be more resistant to such shocks.
Trades wherein yuan is borrowed to purchase higher-yielding assets are more likely to be more stable as China’s central bank maintains its loose monetary policy, the Royal Bank of Canada says. The yuan carry trade is different from the yen carry trade since it mainly involves exporters and multinationals, not speculators, data from Macquarie Group Ltd. show.
Carry trades, which seek to capitalize on differences in global rates of interest, took center stage in financial markets in early August because the unwinding of the yen fueled a sell-off in dangerous assets. Investors bought their assets after a rate hike by the Bank of Japan strengthened the local currency, which in turn depressed the worth of higher-yielding goal currencies corresponding to the Mexican peso and Brazilian real.
“It still makes sense to short the yuan against a basket of emerging market currencies, as it would be contradictory to allow the currency to strengthen when the central bank is trying to ease its monetary policy,” says Alvin T. Tan, head of Asian currency strategy on the Royal Bank of Canada in Singapore.
“China’s economy is in trouble and the PBoC is widely expected to further ease its policies in the coming months. In fact, it has signaled this,” he said.
A carry trade that borrows yuan and invests it in a basket of eight emerging market currencies has returned 0.5 percent this quarter, while the yen-funded alternative has fallen about 7 percent, in keeping with data compiled by Bloomberg.
The collapse of the yen carry trade following the BoJ’s July 31 decision affected the yuan, at the very least initially. The yen rose 6.8 percent within the week to August 5, while the yuan gained 1.7 percent. Gains within the funding currency for a carry trade can wipe out potential gains.
Important differences
There are a variety of key differences between carry trades in yuan and yen. The yuan isn’t fully convertible since the authorities limit the inflow and outflow of foreign currency to strengthen their control over the economy. This routinely reduces the dimensions of carry trades in yuan in comparison with those in yen.
Second, while yen-funded deals are invested in a big selection of overseas destinations, the majority of deals using borrowed yuan are held in dollars by Chinese exporters and multinationals, which only became profitable in 2022 after Federal Reserve rate of interest hikes pushed U.S. borrowing costs above Chinese ones.
Chinese exporters and multinational corporations have amassed over $500 billion in Dollar holdings since 2022, in keeping with Macquarie.
There are a variety of the reason why investors are fascinated by the yuan carry trade, says Wee Khoon Chong, a senior Asia-Pacific markets strategist on the Bank of China (BNY) in Hong Kong.
“The continued high liquidity of the offshore yuan may simply make it too difficult for market participants to resist the temptation to enter carry trades again once market volatility subsides,” he said.
Still, the general volume of yuan-funded carry trades is more likely to be limited since the People’s Bank of China has sufficient tools to forestall what it sees as an excessive buildup of speculative positions, Wee wrote in a client note this month.
“Will offshore yuan shorts build up again? Sure, why not?” he said. “There will always be some opportunistic market participants, but we don’t expect them to emerge in any significant volume.”
Trading recommendations
Many financial firms are telling their clients that issuing yuan bonds will proceed to be a profitable approach to financing carry positions.
Citigroup Inc. recently advised investors to bet on the Mexican peso and Brazilian real against the yuan and yen in the choices market, in keeping with a research report by strategists including Dirk Willer in New York.
Goldman Sachs Group Inc. and Nomura Holdings Inc. also recommend that investors short the yuan against a trade-weighted basket of other currencies as China’s macroeconomic headwinds are large and the U.S. dollar is weaker.
