Gaming the yuan: making money on a state-controlled currency

[HONG KONG] One of the world's least volatile currencies, the yuan was already a challenging trade before China's central bank started stepping up control.

Swings in the yuan have only become more muted since May 26, when the People's Bank of China flagged including an extra factor in the formula used to calculate the daily reference rate, one of its chief tools for managing the currency.

With a twice-a-decade leadership reshuffle in the Communist Party looming - and residual concern over how the exchange rate is viewed by the US - the onus is on officials to keep a grip on the yuan in 2017.

Unhappy at its declining trend, the PBOC is suspected of also intervening in the yuan earlier this month, taking advantage of US dollar weakness to propel it to a seven-month high in Shanghai.

But rather than give up on a currency for which a 0.1 per cent move is headline news, analysts say investors should get creative and capitalise on the yuan's stability.

Beijing said May 26 it would start considering a "counter-cyclical factor" when calculating the yuan's daily fixing - the currency is limited to moving no more than 2 per cent either side of this rate each day.

Some analysts say the authorities were motivated to do this by the currency being consistently weaker than the fixing at the official close each day. Investors should capitalise on this by building short US dollar-yuan positions toward the end of each session on bets the counter-cyclical factor will be used to bolster the yuan the next day, says Zhao Pengyong, a foreign-exchange analyst at GF Securities Co in Shanghai.

Carry Trade

There's nothing like a carry trade, and the yuan is proving to be an attractive bet since the government suggested it was tweaking the fixing in late May (it hasn't confirmed that it has made the change yet).

The currency's Sharpe Ratio, which measures returns adjusted for price swings, has been 4.54 since May 26, exceeding the Indonesian rupiah's 4.48 reading and 2.05 for India's rupee.

Some traders are borrowing the US dollar at US' relatively lower interest rates to invest in the yuan precisely because of the Chinese currency's lack of volatility and expectations it will remain steady, says Zhou Hao, a Singapore-based economist at Commerzbank AG.

Bank on Stability

Don't let the yuan's lack of movement get you down - bet on it.

Wan Zhao, an analyst at China Merchants Bank Co in Beijing, suggests shorting the vega on yuan options - so, betting on the currency becoming even less volatile than it already is.

One-month implied volatility on the yuan is 3.2 per cent, the lowest in the world aside from that for the Hong Kong dollar and the Saudi riyal, both of which are pegged to the greenback. Bets on yuan swings have halved from this year's peak of more than 7 per cent, reached in January.

Go Offshore

When China's central bank wants to burn yuan speculators, it helps engineer tighter liquidity in Hong Kong, home to the currency's offshore market.

Investors could borrow the yuan at medium tenors and then lend the money out when short-term borrowing costs spike, suggests Ken Cheung, a currency strategist in Hong Kong at Mizuho Bank Ltd.

The yuan hit a seven-month high in Hong Kong May 31 and the next day the cost of lending the currency bank-to-bank spiked to 42.82 per cent. That was the highest level since January, when officials were suspected of draining liquidity to squeeze bears amid strong yuan depreciation pressures.

The Magic Number

A key level to watch on the yuan is 6.82 per US dollar, as the PBOC may either arrest its losses or push the currency higher should it weaken below that point, to lure capital inflows, according to Sean Yokota, head of Asia strategy at Skandinaviska Enskilda Banken AB in Singapore. The Stockholm-based bank earned 1.9 per cent by betting in early May on a rebound in the yuan, Mr Yokota wrote in a client note. The yuan has strengthened 0.6 per cent offshore over the past month, and was steady at 6.8305 per US dollar as of 8:38am Tuesday in Hong Kong.

BLOOMBERG