China’s central bank reminds hedge funds that the yuan is a dangerous currency to short-sell

It’s exactly the kind of shock that many hedge fund managers feared as they mulled whether to bet big against China’s currency.

In a surprise statement on Friday night, the People’s Bank of China announced a rule tweak that will make bearish yuan trades much more expensive. The move, which sparked a sharp rally in the currency, echoed efforts to deter short sellers almost three years ago. It also underscored why hedge funds have largely avoided wagers against the yuan in recent months, missing out on one of the world’s most profitable currency trades.

While China’s slowing economy, rising debt risks and escalating trade war with Donald Trump are all pointing to a weaker exchange rate, memories of a dramatic government-engineered short squeeze in early 2016 are still too fresh for many managers to risk getting caught in a repeat.

Even Crescat Capital’s Kevin Smith, a long-time China pessimist who predicts the yuan will sink by at least 50 per cent over the next 18 months, trimmed his bearish positions in recent weeks to lock-in profits as the currency sank toward a 15-month low.

“Nobody dares to intensely build short trades,’’ said Tommy Ong, managing director for treasury and markets at DBS Hong Kong. “Traders were punished a few years ago, and they made very little money, if not losses.’’

Only time will tell whether Friday marks the end of the yuan’s slide or just a pause. Bears like Smith say the most likely endgame is a major devaluation. But other investors are far more sanguine, citing China’s efforts to bolster economic growth, attract foreign investors and prevent capital outflows.