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The hugely popular yen carry trade\u00a0crashed and burned<\/a>\u00a0this month as Japan\u2019s currency surged. A less well-known version of the strategy is likely to be more immune to those kind of shocks.<\/p>\n Trades involving borrowing yuan to buy higher-yielding assets are set to be more resilient as China\u2019s central bank keeps its monetary policy dovish, Royal Bank of Canada<\/a> says. The yuan carry trade differs from the yen one as it mainly involves exporters and multinationals instead of speculators, Macquarie Group Ltd. data shows.<\/p>\n Carry trades, which involve seeking to capitalize on differences in global interest rates, became front and center of financial markets in early August as the unwind of the yen version fueled a selloff in risk assets. Investors cashed out after a Bank of Japan interest-rate hike bolstered the local currency, which in turn hammered the value of higher-yield targets such as the Mexican peso and Brazilian real.<\/p>\n \u201cIt still makes sense to short the yuan against a basket of emerging-market currencies as it would be contradictory to allow the currency to strengthen when the central bank is trying to ease policy,\u201d said Alvin T. Tan, head of Asian currency strategy at Royal Bank of Canada in Singapore.<\/p>\n \u201cChina\u2019s economy is struggling, and the PBOC is widely expected, and has indeed signaled, that it will ease policy further in coming months,\u201d he said.<\/p>\n A carry trade that involves borrowing yuan and investing in a basket of eight emerging-market currencies has returned 0.5% this quarter even as the yen-funded alternative has tumbled around 7%, data compiled by Bloomberg show.<\/p>\n The collapse of the yen carry trade following the BOJ\u2019s July 31 decision did at least initially spill over to the yuan. The yen surged 6.8% during the week through Aug. 5, while the yuan jumped 1.7%. Gains in the funding currency for a carry trade can wipe out possible returns.<\/p>\n There are a number of substantial underlying differences between the yuan and yen carry trades. The yuan isn\u2019t fully convertible as the authorities limit the inflow and outflow of foreign currency to aid their control of the economy. That automatically crimps the size of the yuan carry trades compared to yen ones.<\/p>\n Secondly, while yen-funded trades are invested across a wide range of overseas targets, the vast proportion of those using borrowed yuan are held in dollars by Chinese exporters and multinational corporations. These only became profitable during 2022 after Federal Reserve rate hikes pushed US borrowing costs above Chinese ones.<\/p>\n Chinese exporters and multinationals have amassed over $500 billion in\u00a0dollar holdings<\/a>\u00a0since 2022, according to Macquarie.<\/p>\n There are a number of reasons for investors to be attracted to the yuan carry trade, said Wee Khoon Chong, a senior Asia Pacific markets strategist at BNY in Hong Kong.<\/p>\n \u201cThe ongoing flush offshore yuan liquidity conditions might just make it too hard for market participants to resist reengaging in carry trades as and when market volatility subsides,\u201d he said.<\/p>\n Still, the total size of yuan-funded carry trades may be limited as the People\u2019s Bank of China<\/a> has sufficient tools to prevent what it may see as an excessive buildup of speculative positions, Wee wrote in a client note this month.<\/p>\n \u201cWill offshore yuan shorts be rebuilt? Sure, why not?\u201d he said. \u201cThere will always be some opportunistic market participants out there but we do not see it to be significant size.\u201d<\/p>\n A number of financial firms are telling clients that borrowing yuan will continue to be a profitable method of funding carry positions.<\/p>\n Citigroup<\/a> Inc. recently advised investors to bet on the Mexican peso and Brazilian real against the yuan and yen in the options market, according to a research report from strategists including Dirk Willer in New York.<\/p>\n Goldman Sachs<\/a> Group Inc. and Nomura Holdings Inc. are also among those recommending investors short the yuan against a trade-weighted basket of other currencies due to China\u2019s challenging macro headwinds and the softer US dollar backdrop.<\/p>\n<\/div>\n\nKey Differences<\/h3>\n
Trade Recommendations<\/h3>\n
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