TUMBLING CHINESE YUAN SETS OFF "CARRY TRADE" ROUT, TRIGGERS DERIVATIVES CONTRACTS / THE TELEGRAPH

Tumbling Chinese yuan sets off 'carry trade' rout, triggers derivatives contracts

The yuan has lost 3pc since January, a clear break with China’s long-standing policy of slow appreciation

By Ambrose Evans-Pritchard

5:54PM GMT 20 Mar 2014
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China seems to be weakening the yuan deliberately Photo: AFP

China’s yuan has suffered its biggest one-week fall in 20 years, nearing key trigger levels that threaten a wave of forced selling and mounting stress for those with dollar debts.

The jitters come amid reports of fire-sales of Hong Kong property by Chinese investors desperate to raise cash, some slashing their prices by 20pc for a quick sale. A liquidity squeeze in mainland China has already led to the collapse of Zhejiang Xingrun real estate this week with $570m of debts, the biggest property failure so far.

The yuan weakened sharply on Thursday to 6.23 against the dollar and has now lost 3pc since January, a clear break with China’s long-standing policy of slow appreciation.

Geoffrey Kendrick, from Morgan Stanley, said the currency has broken through the 6.20 level where a cluster of structured products are triggered. These are known as losses on target redemption funds. The losses have already hit $3.5bn.

The latest move creates a potential “non-linear movement” that could push the yuan rapidly to the next level at 6.38, where estimated losses would reach $7.5bn, and from there jump to 6.50.

Mr Kendrick said banks in Singapore, Taiwan and South Korea are heavily exposed, but there could also be a serious fallout for Chinese airlines, shipping and property companies, as well as a nexus of finance built around use of copper and iron as collateral.

Chinese companies have borrowed $1.1 trillion on the Hong Kong markets, a quarter from UK-based banks. There is complex web “carry trade” of positions in which investors borrow in dollars to buy yuan assets, often with leverage. These trades are highly vulnerable to a dollar squeeze as the US Federal Reserve brings forward its plans for rate rises.

Morgan Stanley said the Chinese central bank may have to intervene to shore up the yuan by selling some of its US dollar bonds if the slide goes much further. The authorities spent $80bn in June/July 2012 to defend its currency band.

For now China seems to be weakening the yuan deliberately. Mark Williams and Qinwei Wang, from Capital Economics, said the data flow suggests that the central bank bought $25bn of foreign bonds last month in order to force down the currency. The motive is to teach speculators a lesson and curb hot money inflows.  

However, suspicions are also are growing that China’s authorities have quietly switched to a devaluation policy to buffer the shock to the economy as they attempt to curb excess credit, even though this would risk a clash with Washington. “The more they undershoot their growth target, the more tempting it may look to have a weaker currency to help out,” said Kit Juckes, from Societe Generale.

Premier Li Keqiang said on Thursday that China would take steps quickly to “stabilise growth and boost domestic demand”, a sign Beijing is worried that tightening may have gone too far. Credit Agricole expects the central bank to slash the reserve requirement ratio for banks by 200 basis points this year.

Morgan Stanley said China is approaching a “Minsky Moment”, a turning point when credit bubbles implode under their weight. “There is evidence that this debt growth has become excessive and non-productive. It now takes four renminbi of debt to create one renminbi of GDP growth from a nearly 1:1 ratio in the early and mid-2000s.”

“It is clear to us that speculative and Ponzi finance dominate China’s economy at this stage. The question is when and how the system’s current instability resolves itself,” said the bank.

“A disorderly unwind could take Chinese growth down to 4pc in a shorter time frame with potentially disastrous consequences for levered Chinese assets (banks, property) and the entire commodity supply chain,” it said.