For forex speculators around the world, one transaction has always been an incredibly simple operation: borrowing the Japanese yen, because JapanRate of interestDown to zero and costs almost nothing, so put your money where the yield is high and earn a good spread on it.
Now, another low costfinancingcurrency──RMB. Over the past month, as the yuan’s exchange rate fell toward historic lows, Invesco, Goldman Sachs, Citigroup and TD Securities have recommended the yuan as a good funding currency option in so-called carry trades.
Policymakers in Beijing have been struggling to defend the yuan and fight speculators, which have made it more expensive to borrow the currency in foreign markets in recent days, but supporters of the yuan carry trade remain undeterred. He said such operations are not just about making profits or diversifying risks, but also reflect the fluctuations in the strength of Asia’s two largest economies, Japan and China.
After decades of stability, Japan’s inflation has finally begun to rise, with early signs suggesting the economy is recovering. The market also anticipates that the Bank of Japan will eventually end its seven-year negative interest rate policy. But for China, the yuan being chosen as the new target for the carry trade highlights the difficulties China’s economy is experiencing. Heavy debt, sagging real estate and deflation concerns have prompted China’s central bank to cut its benchmark interest rate twice since June to a historic low of 1.8%. Many expect interest rates to be cut, which will weaken the yuan and lower borrowing costs.
Dirk Willer, global head of macro and emerging markets strategy at Citigroup, said: “If you think the Bank of Japan is making something, you have to be careful that the yen is going to be stronger, and the People’s Bank of China is still monetary. Simplifying the policy.” The weakening of China’s economy “is a key to these types of transactions.”
This month, his team advised clients to sell the yuan against a basket of currencies including the US dollar and the euro.
Of course, there are several caveats that should be attached. No one is suggesting that the yen carry trade is over, nor that speculators will abandon the yen for the yuan. So far this year, buying property in Latin America using the yen as the financing currency has been particularly profitable. The benchmark interest rate in Latin America is up to 13.25%. The Brazilian real, the Colombian peso and an equally weighted basket of currencies from Mexico have risen 42% this year, easily outpacing the Nasdaq’s gains.
But using the RMB as a financing currency is not a fixed-profit transaction. Chinese authorities have intervened aggressively in recent days to prop up the yuan in overseas markets, with state-owned banks periodically pulling yuan supplies offshore to drive up financing costs and deter speculators. Last Wednesday, three-month RMB financing costs soared above 4%, the highest in five years.
Additionally, central banks in Brazil, Mexico and Chile have begun cutting interest rates, reducing spreads on some of the most profitable trades.
Ricardo Seabra of Banco de Instimento Global believes that the People’s Bank of China will gradually devalue the yuan, and ultimately the most important thing is to ensure long-term holding positions.
Carry trades are typically conducted using yuan hui. Recently, Lily has been a more profitable business. Currently, Lily’s 3-month forward foreign exchange yield is 10.8%, and the Mexican peso is 11.7%. Since the cost of borrowing RMB funds abroad is 4%, the annual return on the transaction is about 7%, assuming the exchange rate remains stable. (This may not sound like a lot, but since these trades are almost always highly leveraged, the actual profit could be many times higher.)
Ironically, Beijing’s intervention in the offshore renminbi market may actually be a plus, as it dampens volatility and makes profits more predictable. The yuan’s three-month implied volatility is 5.6, the third lowest among major currencies. In comparison, the yen’s implied volatility is 9.3.
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