Move Over Yen, Yuan Carry Trades Could Be Next Ticking Bomb, Warns Strategists: 'But It's Below The Danger Levels We Monitor'

The unwinding of the yen carry trades roiled the global markets on Monday although sanity returned, helping a rebound. Even as analysts sound caution regarding further unwinding that could happen over time and prolong the sell-off, a new threat is likely to aggravate matters further.

Yen Out, Yuan In: Chinese yuan carry trades are on the cusp of being unwound as positioning in the yen is not extreme, according to Citigroup, Bloomberg said in a report. The yen and yuan carry trades are still crowded compared to many of their targets, with the latter standing out, Citi’s quantitative strategists Dirk Willer and Alex Saunders said in a note to clients, the report said.

Carry trade is a strategy through which people take advantage of the low interest rates prevailing in a country and borrow capital to invest in high-yielding assets elsewhere.

There are “more positioning worries on the funding side of the carry trade, and in particular the yuan, rather than on the long carry side,” the strategists reportedly said. They noted that the yuan was “swept up in the popular Trump trades, where the threat of tariffs was supposed to lead toward higher dollar-yuan,” they added.

“Overall, positioning in carry is not clean yet, but it is below the danger levels that we monitor,” the strategists said.

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Why It’s Important: The Bank of Japan’s ultra-loose monetary policy helped the rampant build-up of yen carry trades. As the Japanese currency strengthened amid two rate hikes by the central bank this year and the weakening of the U.S. economy, traders were forced to cover their positions by selling assets purchased using yen-funded loans.

The yuan has weakened 1.42% against the dollar so far this year, while it has strengthened 1.23% since the start of July. The USD-CNY pair is not allowed to float freely like most other major currencies and the exchange rate is controlled by the People’s Bank of China. The central bank fixes the starting level each day at around 9:15 am Beijing time and the yuan will be allowed to trade in a 2% range around the fix.

The recent strengthening of the yuan should be a welcome development for the PBoC, as it might provide leeway for the bank to lower rates in order to kickstart domestic growth, the Bloomberg report said.

The iShares MSCI China ETF MCHI edged down 0.15% to $40.56, according to Benzinga Pro data.

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