China’s squeeze on yuan short-sellers is risky business
‘Putting the squeeze on speculators might ultimately just prove to have created new problems for China’
China’s policymakers may feel well satisfied with their success last week in strengthening the value of the offshore yuan, catching out foreign exchange market participants in a move that also arguably rippled through the wider currency and bond markets. If so, they should enjoy the moment because it may not last.
Traders who had bet that the US dollar would continue to strengthen versus the offshore yuan were forced to exit those trades as liquidity in the Hong Kong yuan market dried up and the overnight yuan borrowing rate soared.
But that long dollar/short offshore yuan trade was only part of a much broader currency market bet on a rising greenback and that yields on US Treasuries would continue to rise. As losses were realised on the short yuan play, long dollar positions against other currencies, as well as bets on higher US Treasury yields, were also unwound.
Perhaps traders sought to generate some profits to offset yuan trade-related losses or perhaps the markets acted on fears that events in the yuan market would prove a precursor to a wider global position adjustment. Either way what happened in Hong Kong’s yuan market surely generated ripples elsewhere for a time.
But the risk is that the Chinese authorities’ triumph will not only be short-lived but that the manner of how it was secured will have damaged the international credibility of the offshore yuan market. Additionally, Donald Trump may even conclude that his campaign rhetoric and post-election tweets have succeeded in getting Beijing dancing to his tune.
“As we head to press the (almost) annual CNH rates squeeze is once again pushing USD/RMB down,” wrote Cliff Tan, East Asian Head of Global Markets Research at Bank of Tokyo-Mitsubishi UFJ in Hong Kong, late last week.
“You can call this two-way volatility but it’s probably not the end of the one-way bet,” Tan wrote. “We’re wary should authorities succumb to a timeless siren which tells them it’s speculators who are frustrating their policy desires and not good old-fashioned, boring fundamentals.”
If Chinese policymakers are thinking of succumbing to Tan’s “timeless siren” they should perhaps be reminded of British Prime Minister Margaret Thatcher’s memorable comment from March 1988 that “there is no way in which one can buck the market”.
Indeed “if China goes another year without serious restructuring,” BTMU’s Tan wrote “then 2018 may show authorities just how decisive markets can be”.
Writing on Friday, Societe Generale analyst Albert Edwards said “this renminbi rally is likely nothing more than a short-term interruption in its decline against the dollar” and that “the Chinese authorities huge intervention to stamp on the hands of currency speculators is a signal that should be heeded. All is not well in the Middle Kingdom.”
If the currency market concurs with SocGen’s Edwards’ judgement, traders will re-establish those short offshore yuan positions and again test Beijing’s resolve.
Then there’s the issue of the offshore yuan’s credibility. It’s all very well for China’s authorities to “stamp on the hands of currency speculators” by draining liquidity out of the offshore yuan market but that’s hardly comforting to investors and corporations who have their own offshore yuan business to transact.
The credibility of the offshore yuan is unlikely to be enhanced by a perception that the People’s Bank of China is prepared to restrict access to funding liquidity as and when it chooses.
There is also the question of how last week’s move by the Chinese authorities to force the offshore yuan higher may be perceived in Trump Towers, given that the US president-elect has repeatedly railed against what he perceives to be China’s complicity in weakening the yuan.
“Did China ask us if it was OK to devalue their currency?,” Trump tweeted on December 4, seemingly unaware of the inconvenient fact that China has actually been leaning heavily against the pace of yuan weakening, drawing down on China’s pool of foreign reserves to do so.
From the Trump team’s perspective, the decision by the Chinese authorities to drain offshore yuan funding liquidity, feeding into the biggest two-day gain for the offshore yuan in history, could be seen as China dancing to Trump’s tune.
Undoubtedly, speculators, who were short of offshore yuan, had their fingers burnt last week but they may well return. Meanwhile there are risks that the credibility of the offshore yuan market may have been adversely affected or even that Donald Trump feels his haranguing of China is paying off.
Putting the squeeze on speculators might ultimately just prove to have created new problems for China.