Investors get fingers burned as yuan declines

Beijing scores victory over speculators by widening trading band as losses from betting on an appreciation of the currency hit US$5.5b

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Investors get fingers burned as yuan declines

Beijing scores victory over speculators by widening trading band as losses from betting on an appreciation of the currency hit US$5.5b

Bloomberg
02 April 2014

China is succeeding in making its currency less predictable. Investors are paying the price.

Clients of commercial banks in the United States have lost about US$2 billion this year on US$332 billion of options betting the yuan would appreciate, while Chinese companies lost US$3.5 billion on US$150 billion wagered on a benchmark forwards contract, data compiled by Morgan Stanley and Depository Trust & Clearing Corp in Washington showed.

These contracts, when including bearish bets, account for more than a third of global trading in the yuan.

After almost a decade of gains, speculators had come to regard the yuan as a one-way trade, leading to a surge in capital inflows that leaves the country vulnerable to a sudden shift in investor sentiment.

Policymakers responded by selling the yuan and widening its trading band, fuelling a record 2.7 per cent quarterly decline that was the biggest among Asian currencies.

“The depreciation was engineered to burn the fingers of speculators,” said David Loevinger, a former senior co-ordinator for China affairs at the US Treasury and now an analyst at TCW. “The People’s Bank of China wants two-way volatility embedded in the market.”

The currency started to weaken in mid-February and declined the most in any quarter since Beijing unified official and market exchange rates in 1994. It slipped to a one-year low of 6.237 per US dollar on March 21 from a 20-year high of 6.0406 on January 14, and has almost erased last year’s 2.9 per cent advance.

The losses in the options market were on outstanding yuan call options reported by US banks, which clients took out to hedge or speculate on the currency. The contracts lost money as the yuan weakened beyond the median pre-arranged exchange rate, known as the strike price, of about 6.05 per dollar.

The yuan’s decline also caught out investors - 90 per cent of them Chinese companies - in the so-called target redemption forwards market. These contracts pay a monthly income as long as the yuan remains above its strike price, and lose double the amount if it falls below a certain level, which was about 6.20 to the dollar, according to Morgan Stanley.

Investors had been complacent about the yuan’s losses, meaning a disorderly unwinding of yuan bets remained a possibility, said Geoffrey Kendrick, the head of Asian currency and rates strategy at Morgan Stanley.

“People have taken this way too easily so far,” Kendrick said. “It’s very clear now that at least for the next three, six months, we are going to continue to have this currency to weaken.”

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