Week in FX Asia – PBoC Takes a Run at the Carry Trade

For many months, the market has been talking up the Chinese yuan with many speculators believing that the psychological six handle was going to be breached sometime soon, as in the first half of this year. It seems that policymakers at the People’s Bank of China (PBoC) have different ideas. Overall, this market is long CNY and adverse moves will be painful. The yuan is closing out this week trading at an eight-month low against the mighty greenback.

The dollar ended at CNY6.1450, the highest closing rate in eight months. At one point during Friday’s session, the dollar hit a 10-month high of CNY6.1808, which was at that time +0.9% higher from the previous sessions close, making it the biggest single day drop in nine years. The central bank’s stance seems to have taken the market by surprise. The PBoC used the usual channels through state banks to “guide” its own currency lower. The bank is obviously taking direct aim at the “carry trade” – borrowing USD at low rates and investing in the higher-yielding yuan, the ideal way to arb interest rate differentials.

The PBoC wants the market to know it’s serious, and is making a significant statement to all those speculators who believed that the yuan’s strength was to take a straight line higher. Data released earlier in the week continues to show that capital inflows remain healthy in January. State banks brought net $76.3 billion in the month, a 12-month high. It seems that both domestic and overseas interest prefer buying the yuan while shorting foreign currencies. The PBoC’s actions this week should have more seasoned speculators second-guessing their direct strategy route.

In the fixed-income space, Chinese bonds ended up trading lower as investors mostly took profit upon being the shut out for another month (Chinese 10’s backed up +10bps to +4.28%). The bond market remains apprehensive about potential downside risks due to expectations that Chinese funding costs could remain high throughout the year.

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