The Chinese yuan is increasingly being recommended by financial institutions like Goldman Sachs, Citigroup, Invesco, and TD Securities as an attractive alternative to the Japanese yen for funding carry trades. This shift is primarily driven by the yuan's weakening trend towards historical lows and the diverging economic conditions and interest rate policies between Japan and China. While the yen has traditionally been the go-to low-cost borrowing currency due to Japan's sub-zero interest rates, the yuan's recent depreciation makes it a more appealing option for investors seeking higher yields elsewhere.
Historically, the yen carry trade involved borrowing at virtually no cost in Japan and investing in higher-yielding assets globally. This strategy has now become vulnerable due to recent hawkish comments from the Bank of Japan (BOJ) Governor Kazuo Ueda and board member Hajime Takata, leading to increased bets on BOJ interest rate hikes. This expectation has caused a significant unwinding of yen-funded carry trades, pushing the yen to a one-month high against the dollar and nearing levels last seen in May after Ministry of Finance intervention.
The yuan carry trade, while similar in principle, has distinct characteristics due to China's not fully convertible currency. A large portion involves Chinese exporters retaining earnings in dollars to benefit from higher yields, sometimes up to 5% annually, compared to paltry yuan deposit returns. Foreign investors also engage by borrowing cheap offshore yuan to invest in mainland markets or converting it to other currencies for global investments. This strategy benefits from both the yuan's depreciation and the returns on assets. Macquarie estimates Chinese exporters and multinational companies have accumulated over $500 billion in foreign currency holdings since 2022, highlighting the scale of this activity.
While the yuan carry trade is currently smaller than its yen-funded counterpart, given the yen's greater liquidity and openness, its potential for growth is significant. The recent unwinding of the yen carry trade has led to the yuan strengthening against the dollar, raising questions about the stability of yuan carry trades. UBS has noted a decrease in short positions in the offshore yuan, indicating its correlation to the yen. The future unwinding of onshore yuan carry trades is contingent on a rise in Chinese yields and a convergence of dollar-yuan interest rates, alongside a decisive policy stimulus that could boost China's domestic demand.
