Offshore Yuan Bets Losing $3.5 Billion, Morgan Stanley Estimates
An estimated $3.5 billion has been wiped off the value of offshore yuan structured products as China’s slowing economy and mounting credit concerns weaken the currency, according to Morgan Stanley.
Losses on Target Redemption Forwards were probably around that amount at an exchange rate of 6.2 per dollar, a level breached today in Hong Kong for the first time in almost a year, the U.S. bank said in a research note today. A slide to 6.38 is probable and that would boost losses to $7.5 billion, according to the note. Some $350 billion of TRFs have been sold since the start of 2013 and $150 billion of the products remain, the lender estimated in a Feb. 26 report.
“It’s inevitable the currency keeps weakening, and the higher-volatility environment implies that the pace will be quicker,” Geoffrey Kendrick, head of Asian currency and rates strategy at Morgan Stanley in Hong Kong, said in a phone interview today. “Data has been weak, and we have some credit concerns coming up.”
The offshore yuan dropped 0.36 percent to 6.2088 as of 2:27 p.m. in Hong Kong, according to data compiled by Bloomberg. That extended its decline this month to 1.4 percent. One-year implied volatility, a measure of exchange-rate swings used to price options, rose 1.01 percentage points to 3.47 percent in the past month. The gauge will advance to 4.2 percent and possibly as high as 6.5 percent, Morgan Stanley said in today’s note.
TRFs betting on yuan appreciation are losing money as China’s central bank guides the currency lower with weaker fixings and this week’s widening of the trading band allows greater scope for declines. The yuan’s slide comes as economic data has trailed estimates and the nation’s first corporate bond default may foreshadow more to follow. China is targeting growth of 7.5 percent this year, which would be the slowest pace since 1990.
The onshore yuan tumbled 0.57 percent today to 6.2323 per dollar in Shanghai, China Foreign Exchange Trade System prices show. One-year implied volatility has jumped 92 basis points in the past month to 3.07 percent.
Corporates, which make up about 90 percent of TRF holders, will have to post more collateral and some may default on the products, adding to the strain on banks, Kendrick said in the interview. More than 50,000 businesses ran into trouble five years ago when derivatives trades in China, South Korea, India, Indonesia, Brazil, Mexico and Poland turned sour as local currencies unexpectedly plummeted during the global financial crisis, causing at least $30 billion of losses.
Chinese policy makers are seeking to safeguard growth while reining in rapid credit expansion. Exports slid the most since 2009 in February, while consumer prices rose at the slowest pace in 13 months. Two weeks after a solar energy company became the first onshore bond issuer to default this month, a regional developer collapsed with unpaid debt. The economy will expand 7.4 percent this year, according to the median of 55 estimates in a Bloomberg survey.
To contact the reporter on this story: Justina Lee in Taipei at firstname.lastname@example.org