Offshore Yuan Forwards Show Bears' Confidence Has Been Shakenby
Contracts' discount to spot rate is near a one-month low
Onshore yuan jumped Monday by most since peg scrapped in 2005
Global investors are winding in bets on a yuan devaluation as a dollar rally reverses at the same time as China strengthens support for its currency.
Twelve-month forwards for the offshore yuan rallied 2 percent so far this month in Hong Kong, outperforming the exchange rate’s 1.2 percent gain, data compiled by Bloomberg show. The contracts are about 3.5 percent weaker than the spot rate, a gap that reached a one-month low of 3.3 percent on Thursday after widening to a record 5 percent in January. All of the Group of 10 currencies have gained ground on the dollar in February as prospects for a U.S. interest-rate increase dimmed.
“The bears are being challenged,” said Sim Moh Siong, a foreign-exchange strategist at Bank of Singapore Ltd. “The verdict is out whether the dollar weakness will continue. What’s happening in Asian and emerging-market currencies right now rests on what the Fed is going to do and whether it will hike or not.”
The pullback in bearish bets against the yuan will provide some relief for China, which tightened curbs on capital outflows and burnt through almost $300 billion of its foreign-exchange reserves in the last three months propping up the exchange rate. Officials including central bank Governor Zhou Xiaochuan have voiced support for the currency this year and articles in state-controlled media were used to warn that bets against the currency would fail.
Twelve-month forwards for the offshore yuan fell 0.4 percent to 6.7512 per dollar as of 3:11 p.m. in Hong Kong, snapping a five-day run of gains. The spot rate declined 0.2 percent to 6.5144. In Shanghai, where financial markets were shut last week for the Lunar New Year holiday, the currency jumped 1.3 percent on Monday from its Feb. 5 close before retreating 0.2 percent on Tuesday to 6.5097. A strengthening of the onshore rate to 6.48 would trigger further capitulation by yuan bears, Sim said.
“As for the shorters, they need to see further pullback in the dollar for them to get out of their yuan trades,” Sim said. “Right now we’re seeing people de-risking rather than putting on new trades.”
Federal Reserve Chair Janet Yellen said last week the central bank was assessing the impact of the swings in the markets on the economy but she doubted that would prompt it to reverse course and cut rates. There’s about a 30 percent probability the Fed will raise interest rates in 2016, according to futures data compiled by Bloomberg. The odds were more than 90 percent at the end of last year.
Societe Generale SA recommends investors buy the offshore yuan against the Taiwan dollar in the forwards market, saying the trade will perform well even if the Chinese currency depreciates. The French lender predicts the yuan will weaken to 6.80 per dollar in Shanghai by the end of the year.
The odds of the yuan weakening beyond 7 this year have fallen to 23 percent from 28 percent at the end of January, options prices show. Forwards and options contracts are derivatives linked to an underlying security such as currencies or commodities.
“The weakening of the dollar lately has put pressure on depreciation expectations with bearish bets getting stopped out,” said Khoon Goh, a senior currency strategist at Australia & New Zealand Banking Group Ltd. in Singapore.