By Winni Zhou and Summer Zhen
SHANGHAI/HONG KONG (Reuters) – A global markets sell-off spurred by an unwinding of yen-funded carry trades has turned the spotlight on China’s yuan, which is also used widely as a cheap funding currency.
While August has seen the yuan rise sharply by 2% against the dollar, traders say yuan carry trades are distinct and unlikely to unravel anytime soon.
WHAT IS THE YUAN CARRY TRADE?
In typical carry trades, investors borrow low-yielding currencies such as the Japanese yen and Swiss franc to invest in higher-yielding assets, mostly currencies but also to finance leveraged trades in stocks.
The yuan carry trade is similar, but with limitations because the currency is not fully convertible.
A large proportion of yuan carry trades are by Chinese exporters parking cash in dollars. In another version, foreigners borrow yuan to invest in mainland markets. A third type of carry trade involves using the cheap offshore yuan to buy bonds denominated in dollars and other currencies.
HOW DID THE YUAN CARRY TRADE EVOLVE?
Until 2022, when the Federal Reserve started aggressively raising rates and Beijing moved to an easing bias to aid a struggling economy, Chinese interest rates had for years been higher than their U.S. counterparts.
As dollar yields surged, Chinese exporters found they could earn as much as 5% a year if they retained their earnings in dollars, compared to paltry returns on yuan term deposits.
Rampant dollar hoarding by exporters has been a major factor behind the yuan’s depreciation since April 2022.
The yuan’s depreciation meant foreigners could trade dollar-yuan swaps onshore, earning a fat spread on these trades. Overseas investors could borrow cheap offshore yuan and convert those into U.S. dollars or other currencies to invest in stocks and bonds. The investors would benefit from conversion rates as the yuan depreciated, as well as the usual return on the assets.
HOW LARGE IS THE YUAN CARRY TRADE?
It is hard to gauge the total size of the yuan carry trade, according to analysts, but it is smaller than yen-funded global trades, given the yen is a more liquid and open global currency.
Macquarie estimated Chinese exporters and multinational companies have accumulated foreign currency holdings of more than $500 billion since 2022.
Foreign companies have also been sending more of their earnings from China abroad instead of reinvesting in the country.
Meanwhile, foreign holdings of onshore yuan bonds increased by 920 billion yuan ($128.12 billion) since the end of 2022 to a record high in June, official data showed. That is evidence of what traders call the reverse yuan carry trade, in which foreign investors profit from lending U.S. dollars and borrowing yuan via currency-hedged swap trades and then buying yuan bonds.
COULD CHINESE YUAN BE THE NEXT CARRY TRADE TO UNWIND?
The recent unwinding of the hugely popular yen carry trade after Japan raised interest rates sent the yuan higher and raised questions about the viability of yuan carry trades.
UBS said short positions in the offshore yuan have decreased given the currency’s correlation to the yen.
Onshore carry trades could unwind if and when Chinese yields rise and dollar-yuan interest rates converge.
“The yuan carry trade will unwind once China’s domestic demand turns around,” said Macquarie’s chief China economist Larry Hu. “It then depends on when policy stimulus could become decisive enough.”
($1 = 7.1809 Chinese yuan)
(Reporting by Shanghai Newsroom and Summer Zhen in Hong Kong; Editing by Vidya Ranganathan and Jamie Freed)
