Traders are More Bearish on Yuan Than They Are on Argentine Peso

Market Rout Deals Emerging Assets a Violent Blow
  • Hedging cost on China's currency among most expensive globally
  • One-month yuan forwards fall to near four-year low on Monday

In a sign of just how distressed the Chinese market has become, traders are more bearish on the yuan than they are on the currency of Argentina, a country which suffers from a bond default, a stagnant economy and the second-highest inflation in the world.

Costs to protect against further declines in the yuan, as measured by one-month implied yields on so-called non-deliverable forwards, rose to a high of 18 percent on an annualized basis on Monday, up from 2 percent at the end of July. That was the second-most expensive hedge among 31 major currencies tracked by Bloomberg after the Peruvian sol, surpassing those of the Argentine peso, Brazilian real and the Russian ruble.

Once an anchor of stability in the global economy, China shocked investors with the biggest devaluation in two decades this month after loosening control over the yuan in the currency market. While the People’s Bank of China said the adjustment aims to move towards a market-determined exchange-rate regime, it raised concerns that the economy is weakening so much that policy makers are willing to let the currency fall to spur export-led growth.

“Sentiment is really negative right now, with all the economic data coming out really not supporting us at all,” Kelvin Tay, Singapore-based regional chief investment officer at UBS Wealth Management, said on Bloomberg Television.

The yuan has lost 3 percent to 6.4044 per dollar since Aug. 11 when the central bank allowed the currency to fall 1.8 percent in the biggest selloff since 1994. Since the move, global stock markets have wiped out more than $5 trillion in value while commodity prices tumbled to the lowest since 1999 and a rout in emerging-market currencies deepened.

China Rout

Chinese assets continued to decline on Monday with the Shanghai Composite Index of equities plunging 8.5 percent to erase its gains for the year. A private manufacturing index fell in August to the lowest level in six years, signaling a further deterioration in growth in the world’s second largest economy.

One-month yuan forwards, which investors use to protect against or bet on swings in the currency, sank to 6.4735 per dollar in New York on Monday, near the lowest in four years. The implied yield is calculated by taking the difference between the spot price and forward rates. The higher that number, the more expensive it is hedge against a currency’s decline. The yield was at about 14 percent at 11:34 a.m. in New York, down from more than 18 percent earlier in the day.

The cost to hedge the yuan jumped above the price traders pay for derivatives on the currencies of some of the most distressed developing nations. The measure for Argentina’s peso traded at around 16 percent, while those of Brazil and Russia were priced at 14 percent and 13 percent respectively.

Overvalued Currency

Argentina’s peso, which is controlled by the government, has fallen 8.7 percent this year after tumbling 23 percent in 2014 and 25 percent in 2013. President Cristina Fernandez de Kirchner’s government has pledged not to devalue the peso before elections on Oct. 25.

In Brazil, Latin America’s largest economy, a sweeping graft scandal engulfing state-run oil giant Petroleo Brasileiro SA and the country’s biggest builders has pushed the nation toward its deepest recession in a quarter-century and left President Dilma Rousseff fighting for her political survival. The real has slumped 25 percent this year.

While currency strategists don’t see massive devaluation of the yuan, banks including UBS Group AG to HSBC Holdings Plc are racing to slash their forecasts. The median estimate is for the yuan to drop 1.5 percent to 6.5 per dollar by year-end, according to 17 analysts who updated their estimates since Aug. 11. Barclays Plc and Citigroup Inc. are the most bearish, expecting a 5.8 percent fall to 6.8 per dollar by Dec. 31.

Even after the recent decline, the yuan is still overvalued, according to Barclays. The inflation-adjusted yuan exchange rate against the currency of China’s major trading partners has jumped more than 40 percent over the past five years, according to Barclay’s real effective rate.

“There is more yuan weakness to come,” strategists including Guillermo Felices at Barclays wrote in a note on Aug. 24.

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