Easy Currency Bet Gets Harder as the Chinese Yuan Tumbles
2014/02/27
A sharp and sudden slide in China's yuan is forcing investors to rethink one of the most reliable trades in financial markets over the past four years: betting on gains in the Chinese currency.
Since China resumed efforts to move the yuan higher in 2010, traders have piled into bets that profited as the currency has staged a seemingly relentless advance. But after hitting a record against the dollar in mid-January, the currency has dropped over 1%, reaching a six-month low on Tuesday.
China's central bank determines a daily reference point for the yuan, also known as renminbi, then lets it trade 1% higher or lower. Since 2005, it has gradually moved the rate up, allowing the yuan to strengthen 33%. A linked currency, called the "offshore" yuan, trades freely in Hong Kong.
It isn't clear how much the recent decline in the yuan reflects economic fundamentals and how much may reflect a concentrated effort from the Chinese government. The economy slowed somewhat in the fourth quarter, to 7.7% year over year, from 7.8% in the third quarter, which is the way the government measures gross-domestic-product growth. On a quarterly basis the slowdown was even sharper, and analysts say the economy is likely to continue to decelerate in the early part of this year.
A number of recent indicators have showed weakness, particularly purchasing-managers indexes, which have indicated broad retrenchment in manufacturing. Trade figures have been bullish, but those numbers may be distorted by exporters overbilling as a way to get more money past China's capital controls.
But the yuan "is basically still driven by policy makers rather than market forces," noted Royal Bank of Scotland Group PLC's Louis Kuijs in an analyst note. He said the central bank is "keen to move to more exchange-rate flexibility and volatility."
Analysts say China may be trying to shake out short-term speculators, part of a broader effort to reduce the amount of cash sloshing around the country's economy. The move could also be a signal to investors that they should prepare for more volatility in the yuan's exchange rate as the country opens up its financial markets to the world.
While some money managers have held on to their bullish yuan bets, or even added to them, the yuan's recent moves show that, as China's central bank gradually relaxes its grip on the currency, one-way wagers on its appreciation are no longer a sure thing.
China has halted the yuan's rise before. It kept the exchange rate steady for two years after the financial crisis. And in 2012, the yuan was allowed to sink about 1.5% over a roughly three-month period. Since then, it has risen more or less steadily.
Washington has long asked Beijing to give the market a bigger role in the exchange rate, and most of the U.S. political pressure has been for China to let the yuan strengthen, which tends to make American-made goods more competitive by rendering them cheaper by comparison. Policy makers in Washington and other leading economies would be
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