The recent policy changes in Japan and an unexpected rate hike in Taiwan have elevated the yuan's status as a preferred funding currency for the emerging-market carry trade. This shift comes as investors seek alternatives to the dollar amid speculation that the Federal Reserve's easing might not be as forthcoming as once thought.
Carry traders, who profit by borrowing in currencies from low-yielding countries to invest in higher-yielding assets elsewhere, are now finding the yuan more appealing. The yen's appeal has waned due to the Bank of Japan's move away from negative interest rates and the potential for increased volatility and appreciation. In contrast, the yuan offers lower implied yield and volatility, making it a more attractive option than both the Taiwan dollar and the US dollar.
Despite China's economic challenges, the People's Bank of China has maintained a tight grip on the yuan, allowing for minimal appreciation. This control, combined with the currency's low volatility, has positioned the yuan as a viable funding source for carry trades, according to analysts from Wells Fargo Securities LLC and Goldman Sachs Group Inc.
However, the yuan's attractiveness is not without its challenges. Its one-month implied volatility recently hit a low not seen since 2017, but it spiked following a key support level breach. Additionally, the offshore yuan's borrowing costs have decreased, making it cheaper to fund investments in higher-yielding currencies.
Despite these fluctuations, some analysts remain optimistic about using the yen for carry trades, especially if Japan's central bank keeps interest rates low. Meanwhile, unexpected moves like Taiwan's rate hike have dampened the carry appeal of the Taiwan dollar, although it's believed to be a temporary measure.
Investors are also keeping an eye on global economic indicators, including rate decisions from Hungary and South Africa, as well as inflation and unemployment data from Brazil, Malaysia, Poland, Mexico, and Chile, to inform their currency trading strategies.
