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."

Most Popular

The MoneyWeek Podcast: Asia, financial repression and the nature of capitalism
Economy

The MoneyWeek Podcast: Asia, financial repression and the nature of capitalism

Russell Napier talks to Merryn about financial repression – or "stealing money from old people slowly" – plus how Asian capitalism is taking over in t…
16 Jul 2021
Three companies that are reaping the rewards of investment
Share tips

Three companies that are reaping the rewards of investment

Professional investor Edward Wielechowski of the Odyssean Investment Trust highlights three stocks that have have invested well – and are able to deal…
19 Jul 2021
The future belongs to emerging markets – three EM stocks to buy now
Share tips

The future belongs to emerging markets – three EM stocks to buy now

Professional investor Carlos von Hardenberg of Mobius Capital Partners picks three of his favourite emerging-market stocks.
5 Jul 2021