But now, a surprising low-cost alternative to the Japanese currency has started to emerge — this time from China. In the past month, Invesco, Goldman Sachs, Citigroup and TD Securities all recommended the yuan as an attractive option for funding so-called carry trades as it weakens toward historical lows.
“If you think the BOJ is in play, then you get yen strength out of that and need to be careful, while the PBOC is still easing policy,” said Dirk Willer, head of global macro and emerging-markets strategy at Citigroup. A weak Chinese economy is “an important part of that trade.”This month, Willer’s team recommended clients sell yuan against a basket of currencies that includes the dollar and the euro.
“The PBOC has come in and they’ve made it very clear that they’re concerned,” said Jae Lee, a strategist at TCW Group. That raises the chances yuan-based carry trades can go the wrong way in the near term. While yen carry trades boomed the past two years as just about every central bank outside Japan aggressively raised rates, the worry now is that the BOJ will join in, especially as inflation has topped its 2% target for over a year. Traders recently priced in expectations the bank will raise rates in January.
The rationale is straightforward. The PBOC will need to drop rates to rock-bottom levels to prop up the economy. That will reduce funding costs and weaken the currency — boosting yuan-based carry-trade profits along the way. In the local market, the yuan, which isn’t convertible and out of reach for most foreigners, recently fell to a 16-year low.