China's Efforts to Squeeze Bets Against the Yuan Haven't Achieved Muchby
Yuan interbank rates in Hong Kong surged to records this month
Outflows from China increased to $158.7 billion in December
The cost of betting against the yuan in Hong Kong fell back to where it was at the start of the year, highlighting the shortcomings of China’s attempt to starve the offshore market of funds while flooding domestic banks with cash to support the economy.
The Hong Kong InterBank Offered Rate for three-month yuan loans fell to 4.87 percent last week, 59 basis points lower than the Dec. 31 fixing and down from a record 10.42 percent on Jan. 12. The comparable rate in Shanghai is 3.10 percent and Chris Morrison at $965 million hedge fund Omni Partners says funds will flow offshore, providing a pool of yuan to be borrowed and sold, unless China imposes draconian capital controls.
"The only way to truly deter speculators would be to let onshore interest rates rise sharply, but they cannot do this as it would further depress the Chinese economy," said Morrison, who heads strategy at the London-based firm’s macro fund and has predicted the yuan could fall about 15 percent this year. "It will be too difficult for them to drive a permanent and high wedge between offshore and onshore interest rates."
Yuan borrowing costs in Hong Kong, the biggest center for offshore financing in the currency, had surged to records across all tenors earlier in January as China’s central bank bought the currency after it weakened to a five-year low. That drained supplies in the market and made it more expensive to borrow for short trades, selling borrowed assets in the currency with the aim of profiting by buying them back at lower prices later.
Yuan Hibor is the benchmark used to price loans in the currency outside of China and was introduced by Hong Kong’s Treasury Markets Association in 2013. The overnight rate surged to all-time high of 66.8 percent on Jan. 12 and was at 1.1 percent on Monday. The three-month rate rose 1.43 percentage points on Monday to 6.3 percent on increased demand before the Lunar New Year holidays next week.
China’s action may have served as a warning shot to short-sellers that could deter future bets. Officials are using military analogies to describe the People’s Bank of China’s bruising attack on speculators who were betting against the currency. The People’s Daily wrote in a commentary in its overseas edition that billionaire investor George Soros’s "war" against China won’t succeed.
“The risk-reward of shorting the yuan offshore, even if funding costs have come off, is low given the greater potential for a short squeeze to happen again,” said Sim Moh Siong, foreign-exchange strategist at Bank of Singapore Ltd. “Most players are cautious.”
The PBOC has been buying yuan in Hong Kong since devaluing the currency in August and more so since the offshore exchange rate sank to a record 2.9 percent discount to the onshore level on Jan. 7. The gap raised questions about the yuan’s value before it joins the International Monetary Fund’s reserve-currency basket in October. The yuan was at 6.6052 a dollar in Hong Kong on Monday, weaker than the 6.5787 rate in Shanghai.
“This is the problem the Chinese have with their foreign-exchange policy, it is not consistent with domestic macroeconomic policy objectives,” Morrison said. “And that is why the market will continue to take the other side of the bet. Foreign-exchange and macro policy must sing from the same hymn sheet for it to be credible.”
The yuan has fallen about 5.6 percent in Shanghai since its August devaluation, even as China’s central bank burnt through $321 billion of its foreign-exchange reserves to ease the currency’s slide. Six interest rate cuts since November 2014 of a combined 1.65 percentage points have cut yields in China, with the 10-year sovereign rate dropping to 2.84 percent on Friday, 91 basis points higher than similar U.S. Treasury yields. The gap was as low as 50 basis points at the end of last month.
Many Chinese savers are moving their money out of the nation in fear of further currency weakness after the economy grew 6.9 percent last year, the least since 1990. Outflows from China increased to $158.7 billion in December, the most since September and were $1 trillion last year, according to estimates from Bloomberg Intelligence. That’s more than seven times the amount of cash that left in 2014.
Chinese officials have sought to allay fears of a weakening currency, saying they intend to keep the exchange rate stable and that wagers against the yuan will fail. State-media warned speculators, including billionaire investor George Soros who said he was shorting Asian currencies, not to short-sell the yuan.
“While some short sellers may have been scared away temporarily, I believe there are still plenty of short sellers out there willing to short both onshore and offshore yuan,” said Kevin Smith, founder of Crescat Capital, a $72 million hedge fund in Denver, Colorado, that’s been betting against the yuan since 2014.