CNY Is Replacing JPY As An FX Standard

CNY/USD is emerging as the carry trade of choice for financial institutions, replacing the yen as a new favorite. But what does the move mean for forex markets?

The popularity of the yen has never been in question when it comes to forex. Extremely favorable interest rates in Japan mean that the cost of borrowing yen is attractively low, meaning that its usage for high-yield investments can help generate low-risk profit opportunities for investors. 

Now, China appears to want a piece of the action. In a bid to position the yuan as a low-cost alternative to Japanese currency, we’re beginning to see the yen’s popularity begin to wane. 

Q3 2022 saw the likes of Goldman Sachs, Invesco, Citigroup, and TD Securities all recommend the yuan as a strong option for funding carry trades as it falls towards historical lows. 

Carry trades refer to borrowing currency at a low interest rate to invest at a higher rate of return, and have been a source for investor activity for the yen, but early indications suggest that the tide may be turning towards another major Asian currency.

With CNY and JPY engaging in a tussle for dominance, we’ve seen plenty of activity within CHY/JPN trading. But could this changing sentiment make waves throughout the world of forex?

Record Highs For CNY/JPY

The Japanese yen has struggled throughout much of 2023, depreciating considerably throughout March and April. While many governmental figures in Japan discussed their concern over forex ramifications, the weakened yen was also acknowledged as a relatively positive factor for their policy objectives. 

However, during this time, CNY/JPY climbed to its highest level since the beginning of the 1990s and posed a danger to the yen owing to China’s economic stature and geographical proximity to Japan. 

China’s rapid appreciation against one of its closest trading partners prompted the Peoples Bank of China (PBOC) to devalue the yuan against the US dollar in a move that decelerated the yen’s weakened position against USD. 

However, the PBOC’s decision also caused other Asia-Pacific currencies to devalue against the dollar such as IDR, INR, KRW, MYR, SGD, THB, and TWD. 

Documenting The Yen’s Struggles

The yen’s ongoing struggles have seen the USD/JPY reach a 20-year peak to further underline the level of depreciation that Japan’s currency is undergoing. 

This cheapening effect on the yen has been caused by myriad factors. Elevated crude oil prices combined with higher inflation rates have sparked concerns that aggressive Fed interest rate hikes are around the corner, paving the way for higher Treasury yields across the curve. 

Because the Japanese economy is dependent on importing energy like crude oil, gasoline, natural gas, heating oil, and diesel, these rising prices have become a key issue. As a result, the Bank of Japan has clarified that it will maintain a loose monetary policy focused on keeping long-term yields low. 

This has caused USD/JPY to continue its strong spell with no immediate signs of a reversal on the horizon. However, China must be careful of weakening correlations despite becoming the new forex standard for carry trading. 

Yuan Must Be Wary Of Weakening Correlations

China’s zero-Covid policy has played a role in forcing the nation to buck global trends and cut interest rates, rather than raising them to combat historically high inflation. This has made CNY a popular asset for carry trades due to the level of profit that investors can expect to receive. 

Despite this, there are certainly some concerns that could undermine the newfound popularity of the currency, particularly among its correlations to Asian counterparts. 

The conscious effort to cut rates has caused a level of weakness that many Asian currencies in CNY’s orbit are struggling to overcome. 

Currencies like the Japanese yen and Malaysian Ringgit both hold a strong correlation with CNY owing to significant trade links, but other assets like the Indonesian rupiah, Vietnamese dong, and Taiwan dollar are shaking off their links to the Chinese currency with the correlation of the dong at close to zero in 2023. 

Correlations with the Indonesian rupiah are close to negative, with the currency holding up against inflationary pressures and benefiting from an improved growth outlook. 

With these weakening correlations pointing to CNY’s orbit weakening, should forex traders look deeper into Southeast Asian markets for opportunities? 

Focus Returns To Growing Asian Trends

Forex traders must be wary of the volatility that this role reversal in Asia can bring. China’s low rates associated with the yuan have helped to buoy a healthy carry trade ecosystem but will these advantageous rates be sustainable over the long term? 

For those using MT5 terminal or using a broker that uses MT5 as their terminal supplier, MetaQuotes that have been implemented for the MetaTrader 5 terminal, it’s possible to forensically look at profit and loss analytics that can provide powerful insights into how trends are performing for respective trading strategies. 

Crucially, this new reporting format, which was launched in September 2023, can break down profit and loss by trade type over time, and offer a more holistic overview of performance that can better highlight evidence of trend reversal before significant losses have a chance to take hold. 

These analytical insights, coupled with fundamental analysis, can help FX traders understand Asian climates and the changing market sentiment towards CNY and JPY respectively. Whether CNY’s newfound status as the star of carry trades is sustainable remains to be seen, but thanks to next-generation reporting tools, it’s a trend that can be observed with unprecedented efficiency.