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(Bloomberg) – The Chinese renminbi’s accelerated transformation from a dormant forex market slump into a currency suited to its global competitors has made traders worry about how far it can go without reform and buy its rise.
In London, the world’s currency center, there are more yuan changing hands than ever. Options on the Chinese currency overtake those that refer to the Japanese yen, and buying or selling the yuan is now as cheap as trading the pound sterling. Against this backdrop, there are signs that the renminbi is playing an increasingly important role in influencing broad dollar movements, according to Wells Fargo & Co.
There have been many false dawn in China’s quest to challenge the yuan to other major currencies. But at the root of the explosion this time was a torrent of capital pouring into Chinese markets, fueled by a frantic search for returns with more than $ 14 trillion in debt worldwide paying less than 0%.
This appetite for some of the high yield government bonds in the Group of 20 countries has driven interest in China to a feverish level and is generating demand for liquidity from investors looking to fund and hedge their funds. investments. It also boosts volatility and attracts speculators who have neglected the market for years.
“It’s definitely a leading currency in terms of the flow that we’re seeing,” said Kevin Kimmel, New York-based global e-currency manager at Citadel Securities, one of the world’s largest market makers. “Trade activity in yuan has increased significantly.”
The shift comes as China continues to relinquish control – albeit slowly – of its tightly managed currency, a pillar of Beijing’s long-term plan to encourage its increased global use. China plans to ease restrictions on citizens investing in securities outside its mainland, a move that would facilitate two-way capital flows.
The so-called internationalization of the yuan is integral to the government’s goal of weaning itself off its reliance on the US dollar and what some see as a geopolitical challenge to the greenback’s supremacy. Reducing China’s dependence on the dollar has become more relevant in recent years due to economic tensions with the United States, a trend that will likely continue under the Biden administration.
For now, international investors are encouraged to use the offshore version of the currency, known by its designation CNH in the markets.
While the offshore yuan is theoretically freely tradable – meaning its price can fluctuate with demand, economic data, and geopolitical developments – it generally stays quite close to the onshore unit, CNY for short. And since it is allowed to deviate by just 2% above and below a daily rate set by the central bank, China dominates the currency far beyond its borders – a quirk that could ultimately slow the economy down. ‘adoption.
Growth spurt
Yet despite the limits, the average yuan turnover in London jumped to a record $ 84.5 billion per day in October, according to a central bank survey of the world’s largest currency exchange hub. in the world. In North America, daily volumes more than doubled from the same benchmark last year, to $ 7.8 billion per day. EBS from stock exchange giant CME Group Inc. claims that spot volumes on its platforms in London and New York increased 90% and 131%, respectively, from 2015 to 2020.
Along with this growth in the spot market, there is also a strong demand from investors for instruments to hedge and trade their currency risk. Daily London yuan option volumes hit a record $ 11.7 billion in October, as an average of nearly $ 12 billion in futures changed hands each day, the most since 2019, according to Bank of England data.
“The intention was to allow the currency to float more freely in the market,” said James Hassett, co-head of global emerging markets and G-10 linear FX at Barclays Plc. “It gives people more confidence to trade it.”
At the heart of this metamorphosis are foreign funds, which have steadily poured liquidity into China over the past year, adding to their bond holdings at the fastest pace on record in January. Many are looking for higher yields – Chinese 10-year bonds return 3.3%, compared to around 1.3% for equivalent US Treasuries and less than 0% for German bunds. Others are adding to their holdings to increase their exposure to the country’s assets, which have only recently been included in some of the world’s largest benchmarks.
In this changing landscape, market gauges show that the projected price fluctuations of the offshore yuan over a one-month horizon are now as wide as those of the euro and the yen. While this is in part due to lower fluctuations in these major currencies in the face of unprecedented central bank action, the yuan’s volatility is attracting hedge funds and other quick-capital investors looking to turn a profit.
The additional liquidity has helped reduce the cost of yuan transactions to about $ 20 for every million dollars traded, according to Kimmel of Citadel Securities. It’s similar to the pound and compares to around $ 10 for the Euro-US dollar cross, the most liquid pair in the world. It is well below the spread on emerging market currencies, which “typically exceed” $ 100 per million, he said.
The question is whether all this interest in the yuan can last, especially if yields rise in developed markets like the United States, ultimately diminishing China’s relative appeal. Some of the world’s biggest banks are betting demand will stay, such as Deutsche Bank AG and Citigroup Global Markets Inc. bolstering their dedicated China staff at hubs such as London, New York and Singapore.
These moves echo the call made last year by HSBC Holdings Plc for the yuan to be included in the top currencies. The classic Group of 10 FX label – which includes smaller Scandinavian currencies in addition to behemoths like the dollar, euro and yen – is “outdated and misguided,” strategist Paul Mackel said.
Despite its still small share in world trade – 4.3% as of 2019, according to the latest data from the Bank for International Settlements – the yuan plays an inordinate role in the forex market because its daily movements serve as a key indicator of sentiment of global investors. Wells Fargo strategists, including Erik Nelson, argue that the Chinese currency can even exert an influence on the overall dollar index.
‘Paradigm shift’
The offshore yuan could “weigh more heavily in the battle for global monetary supremacy,” the strategists wrote in a note to clients this month. “If we continue to see signs that the USD / CNH has more influence over the movements of the broader dollar, this could be a significant paradigm shift in the forex markets,” they wrote.
Yet Beijing’s ambitions to make the yuan a truly global currency still face very real challenges.
The share of currency in central bank reserves is around 2%, compared to nearly 21% for the common currency and just over 60% for the US dollar. That’s a terribly low percentage considering the size of China’s economic output. At less than 3%, the renminbi’s share in global payments is only a fraction of that of its biggest competitors, despite increased use.
But it is the age-old issue of restrictions on the movement of capital across Chinese borders that remains one of the biggest headwinds the currency faces, according to Bipan Rai, head of foreign exchange strategy at the Canadian Imperial Bank. of Commerce in Toronto.
“China has made a lot of progress on this front, but it’s still not quite the level of the free movement of capital that you tend to see in other developed markets,” Rai said. “It could be far.”
(Add details in the 6th and 7th paragraphs to show China’s latest move to ease capital controls.)
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