Kyle Bass Sees Potential China-U.S. Currency Pact as Just a Big Yuan Short

(Bloomberg) -- The “strongest ever” currency deal, as U.S. Treasury Secretary Steven Mnuchin has dubbed it, hasn’t shaken the resolve of longtime China bear Kyle Bass.

Any provision for China to keep its currency stable as part of a trade agreement that’s in the works will fail to support the yuan against the dollar, according to the Hayman Capital Management founder. The firm entered its short bet on the offshore yuan in 2015. And Bass is staying the course even as some Wall Street banks revise forecasts to predict strength in the Chinese currency, which is outperforming almost all its counterparts across Asia in 2019.

Bass says it’s just a matter of time before China’s darkening economic picture changes the whole narrative, spurring a weaker yuan and forcing policy makers to eat into foreign-exchange reserves to support it. He argues that China’s $3.1 trillion stockpile -- the world’s largest -- can only fall so far. In his view, a drop below the $1.5 trillion-to-$2 trillion range could impede the flow of trade, much of which is financed in greenbacks.

For him, that means China will eventually have to abandon any pledge for currency stability, sparking a sizable yuan depreciation.

“The Chinese can say they’ll do whatever they can do to keep it stable, but in the end, they’re losing reserves,” Bass said in a phone interview this week. “There’s a number at which the Chinese economy will actually come to a halt, meaning they won’t be able to operate imports and exports.”

Bass, who’s based in Dallas, reaped gains by betting against mortgages during the financial crisis. But not all of his calls in the years since have been as prescient. He predicted a collapse in Japan’s government-bond market -- a stance he said he began sharing publicly in 2010 -- but yields there proceeded to fall below zero.

Reckoning Predicted

In recent years, he’s turned his attention to China, which he says is headed for painful deleveraging after a decade of rapid credit expansion. Should the global economy enter even a mild recession in 2020, that will force a “comeuppance” in China, sparking bankruptcies of state-owned firms and restructuring of the financial sector, Bass says.

That process will end with the yuan 30 percent weaker against the dollar in the next two to three years, he said this week. The call echoed a prediction he’s been making since at least 2016, a period in which other hedge funds abandoned bearish yuan bets. Bass says the devaluation will likely come from a combination of shifting Chinese policy and market forces, as FX reserves shrink and traders wager against the currency.

Market’s Move

“Devaluations aren’t up to the government,” he said. “This will not be up to China, this will happen to China. The market will realize the exchange rate on the screen isn’t close to where it should be.”

Bass said in November at a Reuters conference that he had increased his short position against the offshore yuan, days after it approached its weakest level against the dollar since it started trading in 2010. The currency has rallied around 3 percent since Nov. 1, to about 6.73 per dollar, even amid signs of a weakening economy. Exports slumped almost 21 percent in February, the Chinese government said Friday.

The currency strength follows a turbulent 2018, which saw it tumble about 5 percent against the dollar amid escalating trade tensions, raising speculation that China was deliberately weakening the yuan.

Foreign-exchange intervention has been a focus of U.S. President Donald Trump, who vowed during his 2016 presidential campaign to name China a currency manipulator, though his Treasury Department has declined to do so in its official semi-annual assessments. The U.S. has insisted on currency provisions in its trade agreements in recent years -- including both the renegotiated Nafta and the Obama-era Trans-Pacific Partnership, which Trump abandoned.

What Bass’s view boils down to is that forces in the roughly $5 trillion-a-day FX market will upend any currency agreement this time around.

“To keep it stable, this basically assumes that the Chinese can control the rate at which the rest of the world values their currency,” Bass said. “It’s our view that their ability to do so is slipping.”

--With assistance from Sarah McGregor and Sarah Wells.

To contact the reporter on this story: Katherine Greifeld in New York at kgreifeld@bloomberg.net

To contact the editors responsible for this story: Benjamin Purvis at bpurvis@bloomberg.net, Mark Tannenbaum, Jenny Paris

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