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[LONDON] Two of the three types of hedge funds which bet heavily on a sharp devaluation of China's yuan last year have backed off the trade, leaving only some ultra-bearish "Black Swan" investors holding long-term bets, fund managers and bankers said.
Hedge fund sales desks at four of Wall Street's biggest banks told Reuters that many US players had made money betting against China by the time Beijing took aggressive steps to prop up the currency in early January.
Heavy official intervention, limits on some capital movement and a reduction in the amount of yuan available offshore prompted many players either to cut exposure or walk away from the trade by the Lunar New Year holiday last month, they said.
That has left in place chiefly "tail risk" funds like Mark Hart's Texas-based Corriente Partners or Kyle Bass, who have suggested China would have to devalue the yuan by up to 50 per cent to rebalance its economy.
The yuan fell almost 7 per cent in a steady depreciation in offshore markets that started in November and bottomed out at 6.75 yuan per dollar on Jan. 7. Since then it has recovered roughly half of that value.
Derivatives pricing for the yuan has fallen back to levels not seen since the end of November. "It would seem China would like to hold the line, for a while maybe. We've seen a lot more outflows, a lot of defending of the currency," Mr Hart told Wall Street pay video service www.RealVision.com.
"There have been a couple of engineered short squeezes, which have primarily effected those who had a spread on or those who were short spot CNH." Mr Hart said he still believes China will need to devalue.
The big trade in December and January for hedge funds like Mr Hart's was the low-delta risk reversal, an option contract that only pays out in the event of a very sharp move away from current exchange rates.
Data from the US Commodity Futures Trading Commission and banks' options desks showed large bets going on such options, betting on a fall in the yuan to 7.5-8 per dollar within the next year.
"There isn't a hedge fund on the planet that did not have this trade on somehow but the peak of that positioning is past," said the head of hedge fund sales with one of the six biggest currency trading banks in London.
"It's still a very popular long but it is not at the same peak. The more active FX guys who have been in and out of the spot, a lot of them were squeezed out in February. Then you have the buy and hold, tail-risk sorts of investors. They are still in."
Even so, other bankers and fund managers note that the retreat in pricing on a yuan depreciation has been far less pronounced than it was after Beijing tried and then retreated on a sharp one-off devaluation last August.
Whereas from September the six-month low-delta option fell from highs of 4.4 per cent to 1.8 per cent, this time it has retreated from 4.6 per cent to just under 3 per cent.
The one-year contract in the same periods for comparison went from 9.6 to 4.5 per cent last year, and 10.7 to 7 per cent. "There is a huge divergence between what happened then and what happened in the past month," said Chris Morrison, Head of Strategy with Omni Macro Fund in London. "After the August move subsided the forward points went lower, vols (implied volatility) went lower. This time that has not happened; the market is clearly saying that this stability is temporary. "Ultimately for China it is a stay of execution."