• Mon
  • Sep 15, 2014
  • Updated: 1:24pm
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CURRENCIES

Yuan's sharp drop puts investors on alert for reversal of rising trend

PUBLISHED : Tuesday, 25 February, 2014, 9:55am
UPDATED : Monday, 03 March, 2014, 4:52pm

The yuan has recently been something of a safe haven among emerging market currencies, yet market players have learned from a bloody lesson over the past week that it is no longer an easy, one-way bet.

A sharp fall against the US dollar both onshore and offshore made the yuan the worst performing currency within emerging Asia this month.

The drop offshore - the most since October last year - caused a massive short squeeze. Many investors were forced to buy back contracts at prices higher than what they cost to close out their short positions.

The onshore rate yesterday capped two weeks of losses by falling 0.46 per cent, the most since November 1, 2010. It closed at 6.1266 per dollar in Shanghai, according to China Foreign Exchange Trade System prices reported by Bloomberg.

Meanwhile, the offshore rate shed as much as 1 per cent in the past fortnight.

The correction has shocked the market as the yuan had been deemed the bright spot in the Asian currency market, given its ultra-low volatility and appreciation trend against the dollar.

The era of steady yuan appreciation may be drawing to a close
WANG TAO, ECONOMIST, UBS

China recently reported the second-highest monthly trade surplus in 14 months. A bigger surplus normally provides impetus for the yuan to appreciate.

The People's Bank of China, however, has been setting the benchmark fixed rate for the dollar in terms of yuan higher each day since February 18. That pushed spot rates higher and triggered the short squeeze.

Traders and economists viewed such an unusual move as a signal from the authorities that they are ending the one-way movement of the yuan in the past decade and introducing two-way risk to the currency.

"The era of steady yuan appreciation may be drawing to a close," UBS economist Wang Tao said. "We think the recent weakening of the yuan may signal a change in China's exchange rate policy."

Some also attributed the sudden dislocation in the market to the broader political environment.

At the National People's Congress meeting next month, the central bank will need to report on the progress of Beijing's agenda of further liberalising the capital account and possibly widen the trading band for the yuan.

"As we look for reasons, we need to remember that the yuan is basically still fully in the hands of policymakers," RBS economist Louis Kuijs said.

The sudden change in direction prompted investors to question whether a bigger sell-off in the yuan could be coming.

Most currency strategists maintain their long-term forecast for appreciation of the currency, yet many now expect more volatility and uncertainty in the outlook than they did before the correction.

"We think that after this current bout of weakness, the yuan will likely stabilise in the run-up to the NPC. We also expect the PBOC to widen the band - and maybe this bout of weakness is part of the preparation for that," Standard Chartered economist Stephen Green said.

Although this round of weakness seems close to an end, some foresee a similar episode in the second quarter.

"[The onshore rate] could probably grind back to about 6.05 before the [second-quarter] risks kick in," said Geoff Kendrick, Morgan Stanley's head of Asian foreign exchange and rates strategy.

The key risk Kendrick sees is the mounting default risk of China's trust products. More than 500 billion yuan (HK$635 billion) of such products is due to mature in the second quarter.

"We do not expect defaults to pose systematic risk to the banking sector and the economy, but the headline risk is very likely to move the currency market, especially [the onshore rate]," he said.

As the yuan steadily appreciated over the past few years, structured products became popular among Asian companies, especially those with operations in China. While originally designed to hedge the firms' exposure to a strengthening currency, these products have become a source of monthly income.

Further weakness would leave many investors in the red. For example, the outstanding value of the most popular structured product, a target redemption forward, is estimated at US$350 billion, according to Morgan Stanley.

"If we start to breach 6.15 [onshore], Chinese investors involved in structured products will lose money," Kendrick said.

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4

This article is now closed to comments

ianson
"US$350 billion yuan" - oh, the new co-currency, right.
newgalileo
Months ago Chinese government officials discussed the possibility to ... let the RMB slide down to help the economy. I was not in favor, I told them, as it could reignite calls to ... revalue the RMB and accusations of exchange rate manipulation. So, not that "surprised".
tksiow
If the Japanese can get away with depreciating the yen,why not let the yuan weaken to help in the exports.
jackwong18
It finally comes... The drop in RMB is indeed a good news to HongKongers who suffers greatly from the inflation and currency appreciation on food and commodities due to the US peg!
 
 
 
 
 

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