Winnie Zhou and Summer Zhen
SHANGHAI/HONG KONG (Reuters) – A global stock market sell-off sparked by the unwinding of yen-funded carry trades has put attention on China’s yuan, which is also widely used as a cheap funding currency.
The yuan surged 2 percent against the dollar in August, but traders say the yuan carry trade is clear and unlikely to unwind anytime soon.
What is the RMB carry trade?
In a typical carry trade, investors borrow low-yielding currencies such as the Japanese yen or Swiss franc and invest them in higher-yielding assets – mainly currencies but also to fund leveraged stock trades.
Carry trade in renminbi is similar, but there are limitations as the currencies are not fully convertible.
The vast majority of yuan carry trades involve Chinese exporters holding cash in dollars. In another form, foreigners borrow yuan to invest in the mainland Chinese market. A third type of carry trade involves using a cheap yuan to buy bonds denominated in dollars or other currencies.
How has the renminbi carry trade evolved?
China’s interest rates exceeded those of the U.S. for many years until the Federal Reserve began aggressively raising rates in 2022, forcing Beijing to turn to easing policies to help its struggling economy.
As dollar yields soared, Chinese exporters realized they could earn as much as 5 percent a year by parking their earnings in dollars, compared with the paltry returns on renminbi fixed deposits.
There has been widespread hoarding of dollars by exporters, which has been a major factor in the decline of the yuan since April 2022.
The depreciation of the yuan has allowed foreigners to enter into dollar-yuan swap transactions locally, allowing them to earn large spreads on such transactions. Overseas investors can borrow cheap yuan offshore, convert it into dollars or other currencies, and invest in stocks and bonds. Investors profit from the exchange rate when the yuan falls, plus the normal returns on their assets.
How big is the renminbi carry trade?
Analysts say the overall size of the yuan carry trade is difficult to gauge but is smaller than global yen-financed trade given that the yen is a more liquid and globally open currency.
Macquarie estimates that Chinese exporters and multinational companies will have accumulated more than $500 billion in foreign exchange reserves by 2022 and beyond.
Foreign companies are also increasingly sending profits made in China overseas rather than reinvesting them back home.
Meanwhile, foreign bond holdings have risen by 920 billion yuan ($128.12 billion) since the end of 2022, hitting a record high in June, official data showed. That’s evidence of what traders call the reverse yuan carry trade, in which foreign investors lend and borrow U.S. dollars in currency-hedged swap transactions to buy yuan-denominated bonds and make a profit.
Will the Chinese Yuan be the next carry trade to be unwound?
The highly popular yen carry trade was recently unwound after Japan raised interest rates, sending the yuan strengthening and raising doubts about the viability of the yuan carry trade.
UBS said offshore yuan short positions were reduced given the yuan’s correlation with the yen.
If Chinese yields rise and dollar and yuan rates converge, the domestic carry trade could be unwound.
“The yuan carry trade will be unwound once China’s domestic demand recovers, after which it will depend on when policy stimulus can be decisive enough,” said Larry Hu, chief China economist at Macquarie Bank.
(1 dollar = 7.1809 Chinese yuan)
