Photographer: Xaume Olleros/Bloomberg

The Yuan Is Hong Kong's New Darling as Investors Chase Higher Yields

  • Chinese currency is near a one-year high against local dollar
  • Investors are switching to higher yielding yuan, ING’s Pang

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The big ball of money in Hong Kong is rolling to the yuan, and the local dollar is suffering.

After years of underperforming, the offshore yuan is near its highest level versus the city’s currency in more than 12 months. Yuan deposits in the former British colony have stabilized after halving in the past two years, while buying mainland bonds is more lucrative: benchmark 10-year China government debt yields more than twice as much as its counterpart in Hong Kong.

“The market is trying to look for opportunities for carry using yuan as the long currency because of its higher yield compared to Hong Kong dollar or U.S. dollar products provided in the city,” said Iris Pang, an economist at ING Groep NV. If the yuan’s advance continues, there will be “a lot of such carry activities” across the border in the coming year, she said.

The yuan has climbed more than 5 percent against the Hong Kong dollar in 2017 following a 13 percent slide over the last three years. The city’s currency has been weighed by a wider interest-rate discount to that of the U.S. dollar, and it’s down nearly 1 percent against the greenback year-to-date, passing the mid point of its HK$7.75-HK$7.85 trading band. The Philippine peso is the only other major Asian currency to weaken against the greenback in that period.

The Hong Kong dollar was down 0.09 percent at HK$1.1705 per offshore yuan as of 5:31 p.m. local time Thursday.

Lenders in Hong Kong may have sold up to HK$112 billion ($14 billion) of the local currency into U.S. dollars and converted that into yuan in the first four months of 2017, according to Bank of America Merrill Lynch.

Hong Kong banks are deploying most of their yuan funds as loans, Ronald Man, a North Asia rates and foreign-exchange strategist at BofAML, wrote in a note. If they continue to sell the local currency, money market rates will remain elevated, forward points will turn more negative and the spot exchange rate will come under further pressure, he said. Man expects the Hong Kong dollar to end this year at HK$7.83 compared with HK$7.82 now.

Even the Hong Kong Monetary Authority’s plan to issue extra bills, a move that would drain liquidity, is unlikely to reverse the exchange rate’s depreciation, according to Goldman Sachs Group Inc. News of the plan on Aug. 9 sent the Hong Kong dollar up the most since January 2016 after it neared a 10-year low against the U.S. dollar the previous day, but it has dropped back since.

Here’s a look at the HKMA’s options as the currency weakens.

Party Starting

The onshore Chinese currency’s Sharpe ratio -- a measure of returns adjusted for price swings -- against the Hong Kong dollar was 7 in the past three months, the highest among Asian exchange rates. The offshore yuan’s ratio was 4.7, the third highest, according to data compiled by Bloomberg. This suggests the yuan offers the some of the best carry trade opportunities against the Hong Kong exchange rate in Asia.

Another lure for investors to switch to the yuan is the chance of buying onshore assets, a process helped by China’s new bond-trading link with Hong Kong. The yield on 10-year Chinese government bonds is at 3.63 percent, compared with 1.57 percent on Hong Kong debt of the same tenor.

“This type of yield arbitrage is in play right now, and it’s very favorable for flows to go that way -- to bonds, yuan and even some of the undervalued equity plays,” said Stephen Innes, a senior currency trader at Oanda Corp. He said the switch is being made by a mix of regional high net worth clients, and home-office and smaller institutional clients. “The market is going to be so much larger on the mainland -- the party only has started.”

— With assistance by Tian Chen, and Kana Nishizawa

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