Unraveling the Yuan Carry Trade: What Investors Need to Know
As the global markets experience a sell-off due to the unwinding of yen-funded carry trades, all eyes are on China's yuan, a widely used funding currency. While the yuan has seen a significant 2% rise against the dollar in August, traders believe that yuan carry trades will remain intact for the time being.
What exactly is the yuan carry trade? In simple terms, it involves investors borrowing low-yielding currencies like the Japanese yen to invest in higher-yielding assets, including currencies and leveraged trades in stocks. However, due to restrictions on its convertibility, the yuan carry trade operates differently.
The evolution of the yuan carry trade can be traced back to 2022 when the Federal Reserve began raising rates aggressively, creating a yield gap between Chinese and U.S. interest rates. Chinese exporters found it more profitable to hold onto their earnings in dollars, leading to a surge in dollar hoarding and subsequent yuan depreciation.
The size of the yuan carry trade is difficult to pinpoint, but it is believed to be smaller than trades funded by the yen, a more liquid and open currency. Chinese exporters and multinational companies have accumulated over $500 billion in foreign currency holdings since 2022, while foreign holdings of yuan bonds have reached a record high.
With the recent unwinding of the yen carry trade, questions have been raised about the sustainability of yuan carry trades. UBS noted a decrease in short positions in the offshore yuan, indicating a correlation with the yen. Onshore carry trades may unravel if Chinese yields rise and interest rates on dollar-yuan converge.
In conclusion, the future of the yuan carry trade hinges on China's domestic demand and policy stimulus. As the market dynamics shift, investors must stay informed and adapt their strategies accordingly to navigate the changing landscape of global finance.