Investors take positions to protect against yuan weakening, a signal of waning confidence in Beijing\
Bets are rising that China’s currency is headed lower with its stock market, a signal of waning investor confidence in the country’s ability to manage its economic slowdown and market turmoil.
Activity has ramped up in the yuan options market, where investors are taking positions to protect against a potential weakening of the yuan against the U.S. dollar over the next three to six months.
Those bets have increased after Beijing last week announced measures to support China’s flagging trade sector, including allowing a more market-driven currency.
“The market is implying that a lot of people are expecting a depreciation,” said Cynthia Wong, who heads Société Générale SA’s emerging market Asia fixed income and currencies trading in Hong Kong and Singapore. Ms. Wong said hedge funds have gotten more active over the last couple of weeks, helping send trading volumes of yuan and offshore yuan options up as much as 40%.
The surge in bets is reminiscent of trading earlier this year, when the yuan fell to its weakest level in almost three years against the U.S. dollar and came within a whisker of the level where Beijing allows it to trade.
In the throes of this week’s rout, market expectations, as measured by options-market pricing, are signaling a coming depreciation of the yuan against the U.S. dollar, according to data from Thomson Reuters.
Some investors that have placed bearish bets against the Chinese currency cite their doubts about Beijing’s ability to stabilize its stock market and maintain its decadeslong grip on its currency. The benchmark Shanghai Composite on Monday plunged 8.5% amid speculation that the government was pulling back on unprecedented measures to stem a stock rout.
Another factor adding to investor unease are the seemingly conflicting messages from policy makers. Last week, China’s State Council, or cabinet, signaled it would widen the yuan’s trading band and allow greater fluctuation in the currency. Meanwhile, the People’s Bank of China on Tuesday said it would keep the yuan stable.
The central bank sets a daily reference rate against the U.S. dollar and allows the currency to trade 2% above or below that level.
Charles Feng, Standard Chartered Bank’s head of foreign exchange, rates and credit trading in Greater China, said the statements have stoked confusion. Investors are questioning whether these moves “have been well-coordinated or communicated within the governments various agencies,” including whether the central bank is “on board” with the State Council’s policy statement.
Mr. Feng estimates daily trading volumes of yuan options are currently at about $10 billion a day. If the central bank were to widen the yuan’s trading band, “the market will probably interpret a move to the weak side,” he said.
The debate about the yuan’s direction comes ahead of the International Monetary Fund’s decision later this year on whether to grant the yuan elite status as a reserve currency. The IMF’s Special Drawing Rights basket, which constitutes the fund’s emergency-lending reserves, currently includes the U.S. dollar, the euro, the British pound and the Japanese yen.
That’s one reason why Beijing has kept a firm grip on its currency in recent weeks, holding the yuan traded onshore at its most stable level in almost a decade despite volatility in global currency markets. In contrast, its offshore counterpart, which is freely traded in Hong Kong by foreign investors, has weakened over the past couple months.
Danny Yong, founder of Singapore-based hedge fund Dymon Asia Capital Ltd. and one of Asia’s most closely watched currencies investors, in a letter to his investors last week said he doesn’t expect the currency to weaken with further stock declines. A depreciating currency would create a headache for China, from spurring capital flight to drawing the ire of global politicians seeking to protect trade competitiveness.
“If Chinese equities continue to fall, the Chinese government will have all the more reason to maintain a stable foreign exchange policy and will avoid unnecessary volatility caused by depreciating its currency,” Mr. Yong said in the letter. “Policy makers see more costs than benefits now to weakening the currency…Our view is that a further equity rout for now does not change China’s current foreign exchange policy.”
However, if China’s economic health worsens significantly, Mr. Yong said “the government will use all tools at their disposal including the currency.” China’s economy expanded at a 7% annual rate in the second quarter. While many economists thought that would be hard to reach, it still matches China’s slowest pace of growth in decades recorded in the first quarter.
Betting on a steady yuan was a winning trade for Mr. Yong during an otherwise challenging second quarter for his flagship macro fund. It was one among many global funds rocked by the Swiss National Bank’s surprise January decision to scrap a policy limiting the value of the Swiss franc against the euro.
The fund is still down 6.6% for the year through mid-July, according to investor materials seen by The Wall Street Journal. It surged 19% in 2014.
Representatives for Dymon didn’t respond to requests for comment.
original source: http://www.wsj.com/articles/bets-rise-that-chinas-yuan-will-fall-1438239578