The Chinese yuan is poised to be the next carry trade to unwind
The Chinese yuan could be the next currency to watch after the dramatic unwind of the Japanese yen “carry trade” this week, according to market experts. A wide gap between U.S. interest rates and those in Japan and China has helped fuel the carry trades. It’s a practice in which investors borrow money in a currency from a country with low interest rates, and invest in currencies with higher yields. The investors then profit from the difference in rates, but can lose money if this suddenly changes. In the last few weeks, the Bank of Japan’s rate hike and growing expectations for U.S. rate cuts pushed investors to start unwinding carry trades in the yen. The yen hit 38-year lows against the U.S. dollar in July, but this week accelerated a swift move to its strongest level against the greenback this year. “I think the next potential carry trade to unwind could be the yuan,” Khoon Goh, head of Asia research at ANZ Bank, told CNBC’s ” Squawk Box Asia ” on Wednesday, adding that the market is “starting to see glimpses” of this. Goh was formerly a senior FX strategist at the bank. The offshore yuan — which is traded outside of China— has been steadily strengthening against the U.S. dollar over recent days, and on Monday surged to its strongest level in 2024, falling below 7.1. It was last trading near 7.16. Exporters in focus Goh emphasized that the Chinese government keeps a tight grip on its currency, but argued that China’s reliance on exports could still result in a significant foreign exchange impact. A weaker yuan against the dollar bolstered Chinese exports in the first half of the year . China reported a record-high surplus of $99.05 billion in June, according to data going back to 1981 from LSEG Data and Analytics. Goh said that Asia’s biggest carry trade players are exporters, especially in China. “Look in Asia and China … They’ve been running large trade surpluses. And yet … the currency has continued to weaken,” he said. “Because they were playing the carry trade, they can get much better return on interest rate returns, by putting their money in U.S. dollars.” According to Bruce Pang, chief economist and head of research for Greater China at JLL, official data shows that Chinese businesses were holding the most U.S. dollars via local banks in June since December 2016. But with the U.S. Federal Reserve expected to cut rates as soon as next month, Chinese exporters could decide to begin converting their money back from U.S. dollars — potentially causing “big moves” in some Asian currencies, Goh explained. And it’s not just Chinese exporters who are involved in the yuan carry trade. Non-Chinese investment in yuan-denominated bonds increased by nearly $80 billion in the first half of the year, the second-highest rise in history, according to official data cited by Pang. He said the interest rate gap between China and the U.S. and weaker growth contributed to these trends in the first half of the year, but that such expectations were changing as the U.S. will likely cut rates and China’s economy improves. ‘Positioning worries’ Citi also warned in an Aug. 6 note that the Chinese yuan is one to watch, pointing out there are “positioning worries” surrounding the offshore yuan being used to fund the carry trade. In fact, the “most popular funder” of carry trades recently has likely been the U.S. dollar-offshore yuan pair , said Citi. “The reason is that CNH was also swept up in the popular Trump trades, where the threat of tariffs was supposed to lead to higher USDCNH,” the bank said. The dollar-yen also “sets the scene” for all dollar-Asia currencies “to some extent,” so the yen unwinding did hurt other popular carry funders, and that includes the yuan, Citi added. Yen vs. yuan However, there are some key differences between the Chinese yuan and other major global currencies. Vishnu Varathan, managing director at Mizuho, pointed out to CNBC Pro that the Chinese currency isn’t as liquid or global as the yen. The yuan steadily weakened against the U.S. dollar in the first half of the year, amid concerns about the country’s economy, and that “goes well beyond the rates (differential) story,” he said. “So a CNY-squeeze-triggered carry unwind requires geo-economic risks to fade as well,” Varathan added. And while the Bank of Japan might be raising rates, China’s central bank remains in easing mode as domestic demand has been sluggish. That stance of the People’s Bank of China could actually encourage more yuan carry trades, said Yingrui Wang, China emerging economist at AXA Investment Managers. She did, however, point out the near-term strengthening pressure on the yuan from Chinese exporters who have accumulated dollar receipts in the past few years due to better U.S. yields. “These exporters might start converting their dollar receipts and providing a strong boost to the CNY,” she told CNBC Pro . And while the yen is coming off its weakest levels in decades against the dollar, expectations for the Chinese yuan are more muted. Tao Wang, chief China economist at UBS Investment Bank, said in a note Thursday that her forecast for the onshore yuan this year is between 7.1 to 7.2 against the greenback, from current levels around 7.17.
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