(Bloomberg) — The wildly popular yen carry trade went belly-up this month as the Japanese currency surged, leaving this little-known strategy seemingly less susceptible to such shocks.
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Royal Bank of Canada expects trades borrowing yuan to buy higher-yielding assets to be firmer as the People’s Bank of China keeps monetary policy dovish.The yuan carry trade differs from the yen carry trade in that it is primarily engaged by exporters and multinational companies rather than speculators, according to data from Macquarie Group.
Carry trades, which seek to profit from differences in global interest rates, came to the forefront of financial markets in early August as the unwinding of yen-denominated carry trades accelerated selling of risky assets. Investors cashed out as the Bank of Japan’s interest rate hikes spurred a surge in the local currency and a drop in the value of higher-yielding target currencies such as 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 for the yuan to strengthen at a time when the PBOC is trying to ease monetary policy,” said Alvin T. Tan, head of Asia currency strategy at Royal Bank of Singapore.
“The Chinese economy is struggling and the People’s Bank of China is widely expected, and is showing signs, of easing policy further in the coming months,” he said.
The carry trade, which involves borrowing yuan and investing in a basket of eight emerging market currencies, returned 0.5 percent this quarter even as yen-denominated alternatives fell about 7 percent, according to data compiled by Bloomberg.
The collapse of the yen carry trade following the Bank of Japan’s July 31 decision also spilled over, at least initially, into the renminbi. In the week to August 5, the yen strengthened 6.8% and the renminbi strengthened 1.7%. The rise in the underlying currencies of carry trades could wipe out any potential gains.
Key Differences
There are a number of fundamental differences between the yuan and the yen carry trade. The yuan is not fully convertible because the authorities restrict the inflow and outflow of foreign currency to control the economy. Therefore, the size of the yuan carry trade is automatically smaller than that of the yen carry trade. However, one of the attractions is the stability of the currency that China aims for.
Second, while yen-funded transactions are invested in a wide range of overseas targets, the majority of transactions using borrowed yuan are held in dollars by Chinese exporters and multinational corporations. These transactions only became profitable in 2022 when Federal Reserve rate hikes pushed U.S. borrowing costs above those of China.
According to Macquarie, Chinese exporters and multinational companies are set to accumulate more than $500 billion in dollar assets from 2022 onwards.
Wee Koon Cheong, senior strategist for Asia-Pacific markets at BNY in Hong Kong, said there are several reasons why investors are attracted to the yuan carry trade.
“Given the current abundance of offshore renminbi liquidity, it may be very difficult for market participants to resist re-engaging in carry trade once market volatility subsides,” he said.
Still, the PBOC has ample tools to prevent excessive speculative positions from building up, so the amount of yuan-funded carry trades is likely to be limited, Wee wrote in a client note this month.
“Will the offshore yuan shorts be restructured? Of course, why can’t they?” he said. “There will always be some market participants who jump on the bandwagon, but we don’t see it being on a large scale.”
Trade Recommendations
Many financial institutions have told clients that borrowing in yuan will continue to be a favorable way to fund carry positions.
Citigroup Inc. recently advised investors to bet against the Mexican peso and Brazilian real against the yuan and yen in options markets, according to a research note from strategists led by Dirk Wheeler in New York.
Goldman Sachs Group Inc. and Nomura Holdings Inc. have also recommended investors short the yuan against a trade-weighted basket of other currencies, given tough macroeconomic headwinds from China and a weak U.S. dollar.
What to see:
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Hungary’s central bank is due to announce its interest rate decision on Tuesday, while Israeli policymakers are due to do the same on Wednesday.
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The Czech Republic and Poland will both release their second-quarter GDP figures, and Poland will also release inflation data for August.
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China is due to release its manufacturing PMI data for August, with the past three releases all pointing to contractions.
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Mexico’s central bank will release its quarterly inflation report. Brazil is due to release its August mid-year CPI data.
(Adds background on China’s currency strategy in paragraph 8.)
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