Forex
Explainer-What is the Chinese yuan carry trade and how is it different from the yen’s?
By Winni Zhou and Summer Zhen
SHANGHAI/HONG KONG (Reuters) – A global markets sell-off spurred by an unwinding of yen-funded carry trades has turned the spotlight on China’s yuan, which is also used widely as a cheap funding currency.
While August has seen the yuan rise sharply by 2% against the dollar, traders say yuan carry trades are distinct and unlikely to unravel anytime soon.
WHAT IS THE YUAN CARRY TRADE?
In typical carry trades, investors borrow low-yielding currencies such as the Japanese yen and Swiss franc to invest in higher-yielding assets, mostly currencies but also to finance leveraged trades in stocks.
The yuan carry trade is similar, but with limitations because the currency is not fully convertible.
A large proportion of yuan carry trades are by Chinese exporters parking cash in dollars. In another version, foreigners borrow yuan to invest in mainland markets. A third type of carry trade involves using the cheap to buy bonds denominated in dollars and other currencies.
HOW DID THE YUAN CARRY TRADE EVOLVE?
Until 2022, when the Federal Reserve started aggressively raising rates and Beijing moved to an easing bias to aid a struggling economy, Chinese interest rates had for years been higher than their U.S. counterparts.
As dollar yields surged, Chinese exporters found they could earn as much as 5% a year if they retained their earnings in dollars, compared to paltry returns on yuan term deposits.
Rampant dollar hoarding by exporters has been a major factor behind the yuan’s depreciation since April 2022.
The yuan’s depreciation meant foreigners could trade dollar-yuan swaps onshore, earning a fat spread on these trades. Overseas investors could borrow cheap offshore yuan and convert those into U.S. dollars or other currencies to invest in stocks and bonds. The investors would benefit from conversion rates as the yuan depreciated, as well as the usual return on the assets.
HOW LARGE IS THE YUAN CARRY TRADE?
It is hard to gauge the total size of the yuan carry trade, according to analysts, but it is smaller than yen-funded global trades, given the yen is a more liquid and open global currency.
Macquarie estimated Chinese exporters and multinational companies have accumulated foreign currency holdings of more than $500 billion since 2022.
Foreign companies have also been sending more of their earnings from China abroad instead of reinvesting in the country.
Meanwhile, foreign holdings of bonds increased by 920 billion yuan ($128.12 billion) since the end of 2022 to a record high in June, official data showed. That is evidence of what traders call the reverse yuan carry trade, in which foreign investors profit from lending U.S. dollars and borrowing yuan via currency-hedged swap trades and then buying yuan bonds.
COULD CHINESE YUAN BE THE NEXT CARRY TRADE TO UNWIND?
The recent unwinding of the hugely popular yen carry trade after Japan raised interest rates sent the yuan higher and raised questions about the viability of yuan carry trades.
UBS said short positions in the offshore yuan have decreased given the currency’s correlation to the yen.
Onshore carry trades could unwind if and when Chinese yields rise and dollar-yuan interest rates converge.
“The yuan carry trade will unwind once China’s domestic demand turns around,” said Macquarie’s chief China economist Larry Hu. “It then depends on when policy stimulus could become decisive enough.”
($1 = 7.1809 Chinese yuan)
Investing.com– The Japanese yen exhibited minimal movement on Tuesday, despite Bank of Japan (BOJ) Deputy Governor Ryozo Himino indicating a potential hike in the upcoming policy meeting.
Himino suggested that the central bank might consider raising rates, citing sustained wage growth and expectations of a clearer U.S. policy landscape following President-elect Donald Trump’s inaugural address later this month.
The yen’s pair edged 0.1% higher to 157.62 yen on Tuesday.
In recent months, the BOJ has been adjusting its monetary policy to address rising inflation. In March last year, it ended its negative interest rate policy, and by July, it had increased the short-term policy rate to 0.25%.
These measures aim to achieve a stable 2% inflation target, supported by robust wage growth and a weakening yen, which have contributed to higher import costs.
Despite these developments, the yen’s exchange rate against the U.S. dollar remained relatively stable, reflecting market skepticism about the likelihood of an imminent rate hike.
Analysts suggest that while the BOJ is signaling a shift towards policy normalization, uncertainties surrounding global economic conditions and domestic wage dynamics may lead to a cautious approach.
Barclays (LON:) expects the central bank to implement rate hikes in March and October, with a terminal rate of 0.75%.
The BOJ’s next policy meeting is scheduled for January 23-24, where new growth and price projections will be discussed.
Investing.com — UBS strategists expect the US dollar “to stay stronger for longer,” citing robust US economic activity and ongoing tariff concerns impacting other regions.
Monday saw the (DXY) soar to its highest level since November 2022, trading above the 110 mark during the session. This represents a roughly 9% appreciation since late September.
The US dollar’s recent strength has been bolstered by better-than-expected domestic data, including nonfarm payrolls and the services sector purchasing managers’ index. These positive indicators have led to a decrease in the anticipated number of Federal Reserve rate cuts this year, with the consequent rise in US yields lending broad support to the USD.
While US economic data is expected to remain solid in the near term, the outlook for Europe is less optimistic, with subdued growth prospects.
Although growth in China is forecasted to accelerate to 5% year-over-year for the fourth quarter, the threat of US tariffs poses a significant risk. Political and economic uncertainties in South Korea, the European Union, and the UK have been linked to weakness in their respective currencies.
According to UBS, potential monetary policy divergence is among the key factors that could further propel the dollar upward in the near term.
While the Fed is expected to cut rates by a total of 50 basis points in the second and third quarters, the European Central Bank is projected to reduce rates by 100 basis points in the first half of the year.
“Policy divergence is a powerful driver of currencies, which leads to trending FX markets and the potential for overshooting exchange rates,” strategists led by Mark Haefele wrote.
The firm also points out that tariff risks may not be fully accounted for in the current USD valuation. Despite the dollar’s recent rally being largely attributed to solid US macroeconomic data, the introduction of new tariffs could drive the dollar even higher.
UBS suggests that if tariffs are implemented, the DXY could trade between 110 and 115, with significant impacts on other major currency pairs.
“If tariffs were to materialize, DXY could trade in a 110-115 range, could drop below parity, could slide below 1.20, and could move toward 0.94, in our view,” strategists noted.
However, the investment bank believes that the story of 2025 could be a tale of two halves, with the dollar strength in the first half of the year potentially reversing in the second half.
The current trading position of the USD, which is considered strongly overvalued and shows the highest level of dollar net length since 2015, supports this view.
UBS’s revised forecasts for the EUR/USD pair reflect this expected trajectory. Strategists expect the pair to trade at 1.00 in March, 1.02 in June, and 1.06 in December 2025.
In the case of China, despite the possibility of dramatically higher effective tariff rates, the CNY has only partially priced in this risk, with UBS reiterating its forecast for the to reach 7.50 by June.
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