As China’s efforts to prop up the yuan begin to fade, data due out this week is expected to confirm that a once-popular strategy among foreign investors has lost momentum in August, according to a report by Bloomberg.
This strategy, which led to a fourfold increase in foreign holdings of Chinese bank notes over the past year, involved overseas investors lending their dollars in exchange for yuan to buy short-term bonds. However, returns on the trade have diminished due to weakening demand for foreign-exchange in the swaps market.
The shift is notable because it reflects a reduction in dollar borrowing by Chinese state banks, which had been using foreign-exchange acquired in the swaps market to support the yuan in spot trading. As the Chinese currency stabilises, the need for such indirect intervention has eased.
China’s short-term bank debt had been a favourite investment for huge funds, attracting record inflows for 11 consecutive months, even as other government and quasi-sovereign securities lost favour. With this trade now less attractive, global investors may find fewer opportunities in China’s market, as the country’s sluggish economy and ongoing geopolitical tensions weigh on sentiment toward yuan-denominated assets.
In August, one-year dollar-yuan swap points surged to their highest level since 2008, signalling that returns from lending the US dollar in exchange for yuan have decreased. Last month, foreign investors lent out $1bn of foreign-exchange using one-year swaps, a much smaller amount than before, according to two traders, who also noted that Chinese state banks, once net borrowers of dollars, have shifted to becoming lenders.
In addition to the reduced intervention by state banks, expectations that the Federal Reserve may begin cutting interest rates soon have contributed to this trend. Prior to this shift, the Fed’s rate hikes, combined with Chinese banks’ efforts to support the yuan, had pushed one-year swap points to their lowest level since the global financial crisis.
In July, foreign investors purchased a net RMB118bn ($16.6 billion) in negotiable certificates of deposit (NCDs), bringing their total holdings of this debt to a record RMB1.1tn, according to the latest data from the Shanghai Clearing House.
