An employee counts Chinese one-hundred Yuan banknotes (Photographer: Xaume Olleros/Bloomberg)

Yuan Shorts Staging a Comeback Suggest Cash Crunch Will Persist

(Bloomberg) -- The yuan shorts are back.

Once cowed by the specter of intervention, offshore yuan bears are positioning for further declines again, with implied volatility and forward points both jumping to the highest since at least March this week. While the yuan has stabilized somewhat around 6.9 per dollar this month, signs of faster capital outflows and an imminent Federal Reserve interest-rate increase are fueling speculation that depreciation will quicken again.

These concerns are outweighing Chinese policy makers’ efforts to fend off pressure by driving up funding costs in the onshore and offshore markets. While a Fed rate rise has been in the offing for a while, the chances are almost certain now, and expectations of dollar strength have risen with Donald Trump’s plans to boost the U.S. economy, said Gao Qi, a strategist at Scotiabank in Singapore.

“If depreciation pressure persists, offshore liquidity won’t loosen,” said Gao. “As the yuan continued to break above 6.8 and then 6.9, sentiment has changed. The onshore money market will remain tight.”

There’s a chance the People’s Bank of China will raise benchmark rates in the medium term to curb inflation along with yuan weakness, Gao added. Short-end bonds extended a selloff on Tuesday, with the one-year yield jumping seven basis points to 2.72 percent, the highest since the 2017 notes started trading in August and the most for the similar-maturity benchmark since May last year. In the onshore market, faster inflation and high corporate leverage have added to reasons for the PBOC to tighten funding conditions.

Yuan Shorts Staging a Comeback Suggest Cash Crunch Will Persist

The onshore yuan rate rose 0.08 percent to 6.9032 a dollar as of 4:43 p.m. in Shanghai, halting a three-day loss. It dropped 0.24 percent, the most since September, against a basket of 13 currencies. The yuan’s movement versus the trade-weighted gauge tends to follow the greenback, said Fiona Lim, a senior currency strategist at Malayan Banking Bhd. in Singapore.

Here are some signs suggesting that yuan shorts are returning: 

  • One-month implied volatility in the offshore yuan rose to 6.69% on Monday, the highest since March
  • Three-month risk-reversal rates in the offshore yuan climbed to 1.97% on Monday, near a 4 1/2-month high reached in November
  • Points on 12-month non-deliverable forwards in the yuan reached 2,943.5 on Tuesday, the highest since February

In the rest of China’s currency and fixed-income markets:

  • Government bonds declined, with the 10-year yield increasing one basis point to 3.2% after reaching a one-year high Monday; one-year interest-rate swaps were little changed at 3.29%, data compiled by Bloomberg show
  • The offshore yuan fell 0.07% to 6.9318 per dollar
  • China’s exchange rate has weakened against the dollar mainly in light of Fed tightening, said Mao Shengyong, spokesman for the National Bureau of Statistics. There are conditions for the yuan to remain steady against a basket of currencies due to sound economic fundamentals, he said
  • In November economic data released Tuesday, industrial production and retail sales beat estimates, advancing 6.2% and 10.8%, respectively, while fixed-asset investment climbed 8.3% as projected