Investors bet China needs and wants a stronger yuan

SHANGHAI, Sept 4 (Reuters) – Bets on a stronger yuan are mounting, dealers say, as policies aimed at reviving China’s economy through domestic demand and foreign investment could further boost a currency that has risen more than 4% against the dollar since the end of May.

Helped by the U.S. dollar’s broad decline through August, the yuan has already recovered all the losses it made during the coronavirus pandemic.

But investors are betting on bigger gains as Beijing pursues its “dual circulation” economic strategy, and foreign funds pour into China’s higher-yielding bond markets.

Global investment banks are revising up their forecasts for the yuan. HSBC said this week it expects the yuan, trading currently around 6.8372, to be at 6.7 per dollar by the end of this year, stronger that its previous forecast of 6.95.

Other banks including Goldman Sachs, Union Bancaire Privee, Westpac, ING and SEB have revised their yuan forecasts, favouring it to strengthen.

Several currency traders said they were receiving inquiries and orders from their corporate clients, urgently seeking to convert dollar holdings to yuan to limit exchange losses.

“Long yuan positions have become very crowded recently,” said a trader at a Chinese bank in Shanghai.

Strategists at Citi said they were positioning in both outright trades in the offshore yuan and via options to target the yuan hitting 6.80 in two months.

They cited China’s faster economic recovery, the wide China-U.S. interest rate differentials, improvement in the mainland current account position and strong bond market inflows as factors supporting the yuan.

Analysts expect Beijing’s “dual circulation” strategy, wherein China shifts away from an export-led to a domestically dominated economic growth model, will mean Chinese policymakers will prefer a steady or appreciating yuan.

“Dual circulation is a medium-term aspiration on economic structure,” said Frances Cheung, head of macro strategy for Asia at Westpac. “Still, one may argue that focusing on domestic activities means less concern over exports’ competitiveness and as such, at times when the dollar is weak, there is more room for the yuan to appreciate,” she said.

Ten-year Chinese bonds trade as much as 2.5 percentage points over their U.S. counterparts, and the belief that China’s return to normalcy will preclude further easing is drawing money into those bonds.

Overseas investors increased their holdings of Chinese bonds for the 21st straight month in August to 2.46 trillion yuan, up 42.8% from a year earlier..

Market participants also expect Chinese government bonds will be included in FTSE Russell’s benchmark bond index later this month, and that could bring additional inflows.

“We will see increasing asset allocations towards onshore domestic bond markets, because global investors need to gain yields for their portfolios,” said Peter Kinsella, global head of forex strategy at Union Bancaire Privee. He sees the yuan at 6.65 per dollar by the end of 2021.

The rush to hedge those massive investments has pushed up dollar-yuan swaps, with the one-year contract traded offshore climbing to a three-year high this week.

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