China shocks the carry traders

The Chinese central bank has whipped the rug from under the yuan - and the markets.

The Chinese currency, the renminbi, or yuan, has seen its biggest five-day slide against the US dollar since 1994. It has fallen by 1% since the middle of last week, and on Tuesday posted a record decline of 0.4% against the greenback.

This is only the second major pullback in the dollar-yuan rate since 2005, when the government scrapped a peg against the dollar and began allowing the currency to appreciate very gradually, using a tightly controlled daily trading band.

What the commentators said

There are two explanations for why the authorities engineered this reversal. One is that the currency is at a record high when adjusted for inflation, and the currencies of many emerging-market rivals as well as Japan have become increasingly competitive. The central bank "might also want to hurt carry traders".

The yuan's gradual managed rise, along with comparatively high Chinese interest rates, has always been "catnip for carry-trade investors", agreed Alex Frangos in The Wall Street Journal. And while Beijing has accepted that the yuan needs to rise, it has always been uncomfortable with "the speculative cash that piggybacks" on the trend.

The money flowing in threatens to boost the currency by more than the government wants, hampering the export sector. Beijing wanted to deter speculation by showing the yuan is not a one-way bet.

But why now? Because, according to Capital Economics, a consultancy, Beijing has started to feel that the currency is approaching fair value against the dollar, so it is inclined to shift expectations that the currency will only rise. And it is gradually dismantling capital controls, which have hitherto been the main defence against hot money inflows. So, the central bank is now basically in a fight with the markets, which think the currency should rise further.

The markets are right, said Capital Economics. The current-account surplus is still huge and likely to grow further. And the returns on offer in China remain enticing to foreign money. So while there will be more volatility, expect the yuan to keep rising. "This battle with the markets is one [China] will ultimately lose."

Recommended

The charts that matter: bond yields slip while bitcoin tops $60,000
Economy

The charts that matter: bond yields slip while bitcoin tops $60,000

Cryptocurrency bitcoin soared to over $60,000 this week, while government bond yields fell back. Here’s how that has affected the charts that matter m…
16 Oct 2021
The charts that matter: Brent, bitcoin and bond yields flying high
Global Economy

The charts that matter: Brent, bitcoin and bond yields flying high

Government bond yields continued to climb, along with bitcoin and the oil price. Here’s how that has affected the charts that matter most to the globa…
9 Oct 2021
China’s property woes are spreading beyond Evergrande
Chinese economy

China’s property woes are spreading beyond Evergrande

Instability sparked by the troubles of Evergrande, China’s heavily-indebted property giant, is spreading to the wider property market, and it could af…
5 Oct 2021
The charts that matter: bond yields soar
Global Economy

The charts that matter: bond yields soar

Government bond yields around the world spiked higher this week. Here’s how it has affected the charts that matter most to the global economy.
2 Oct 2021

Most Popular

How to invest in SMRs – the future of green energy
Energy

How to invest in SMRs – the future of green energy

The UK’s electricity supply needs to be more robust for days when the wind doesn’t blow. We need nuclear power, says Dominic Frisby. And the future of…
6 Oct 2021
Inflation is still one of the biggest threats to your personal finances
Investment strategy

Inflation is still one of the biggest threats to your personal finances

Central bankers and economists insist inflation will be gone by next year. We're not so sure, says Merryn Somerset Webb. So if you haven’t started to …
1 Oct 2021
How to invest as we move to a hydrogen economy
Energy

How to invest as we move to a hydrogen economy

The government has started to roll out its plans for switching us over from fossil fuels to hydrogen and renewable energy. Should investors buy in? St…
8 Oct 2021