(Bloomberg) – The accelerated transformation of the Chinese renminbi from a sleepy delay in the foreign exchange market into a currency suitable for rival global pairs has traders setting aside concerns about how far it can go without reform and buy its rise.
In London – the world’s currency center – there are more yuan changing hands than ever before. The options in the Chinese currency exceed those referring to the Japanese yen, and buying or selling the yuan is now as cheap as trading with the pound sterling. In this context, there are signs that the renminbi is playing an increasingly important role in influencing general dollar movements, according to Wells Fargo & Co.
There have been many false dawns in China’s quest for the yuan to challenge other major currencies. But this time, sustaining the explosion is a torrent of capital flowing into China’s markets, fueled by a frantic search for returns with more than $ 14 trillion in debt globally paying less than 0%.
This appetite for some of the highest yielding government bonds in the Group of 20 countries has raised interest in China to a feverish level and is generating demand for liquidity from investors looking to finance and protect their investments. It is also stimulating volatility and attracting speculators who have ignored the market for years.
“It is certainly a cutting edge currency in terms of the flow we are seeing,” said Kevin Kimmel, global head of electronic FX based in New York at Citadel Securities, one of the largest market makers in the world. “Commercial activity in yuan has increased significantly.”
The shift comes as China continues to relinquish control – albeit slowly – of its tightly managed currency, a pillar of Beijing’s long-term plan to encourage its greater global use. China is considering easing restrictions on citizens who invest in securities outside its continent, a move that would facilitate bidirectional capital flows.
The so-called internationalization of the yuan is an integral part of the government’s goal of getting rid of dependency on the US dollar and what some see as a geopolitical challenge to the supremacy of the dollar. The reduction of China’s dependence on the dollar has become more pertinent in recent years due to economic tensions with the United States, a trend that is likely to continue under the Biden government.
For the time being, international investors are encouraged to use the offshore version of the currency, known by its designation CNH in the markets.
While the offshore yuan is theoretically freely negotiable – meaning that its price may fluctuate with demand, economic data and geopolitical developments – it is usually very close to the onshore unit, abbreviated CNY. And since this can be just 2% above and below the central bank’s daily rate, China maintains dominance over the currency far beyond its borders – a peculiarity that may ultimately delay adoption.
Growth spurt
Still, despite the limits, the average yuan turnover in London jumped to a record high of $ 84.5 billion a day in October, according to a survey by the central bank of the world’s largest foreign exchange trading center. In North America, daily volumes more than doubled compared to the same period last year, to $ 7.8 billion a day. EBS, of the giant CME Group Inc., says that spot volumes on its platforms in London and New York increased by 90% and 131%, respectively, from 2015 to 2020.
Along with this growth in the spot market, there is also a heated demand from investors for instruments to protect and negotiate their currency risk. Daily volumes of options on the yuan in London rose to a record high of $ 11.7 billion in October, while an average of almost $ 12 billion of forward contracts changed hands each day, the highest since 2019, according to Bank of England data.
“The intention is to allow the currency to float more freely in the market,” said James Hassett, co-director of global emerging markets and G-10 linear FX at Singapore-based Barclays Plc. “It gives people more confidence to negotiate.”
At the heart of this metamorphosis are foreign funds, which continually poured money into China last year, increasing their holdings in bonds at the fastest rate ever recorded in January. Many are looking for higher returns – China’s 10-year bonds yield 3.3%, compared with about 1.3% for equivalent US Treasury bonds and less than 0% for German bonds. Others are increasing their stakes to increase exposure to the country’s assets, which have only recently been included in some of the world’s largest benchmarks.
In the midst of this changing scenario, market indicators show that the projected price movements for the offshore yuan over the course of a month are now as wide as those of the euro and the yen. While this is partly a function of fluctuations in major currencies falling in the face of unprecedented action by the central bank, the yuan’s volatility is attracting hedge funds and other quick-money investors in search of profit.
The extra liquidity helped to reduce the cost of transactions in yuan to about $ 20 for every million dollars traded, according to Kimmel of Citadel Securities. This is similar to the pound and compares to around $ 10 for the Euro-US dollar cross, the most liquid pair in the world. It is well below the spread in emerging market currencies, which “typically exceed” $ 100 per million, he said.
The question is whether all of this interest in the yuan can last, especially if yields rise in developed markets like the United States, ultimately diminishing China’s relative appeal. Some of the largest banks in the world are betting that demand will remain, with companies like Deutsche Bank AG and Citigroup Global Markets Inc. increasing their dedicated staff to China in centers like London, New York and Singapore.
The measures echo HSBC Holdings Plc’s call last year for the yuan to be included in the upper layer of the exchange. The classic Group-of-10 FX label – which includes smaller Scandinavian currencies, as well as giants like the dollar, the euro and the yen – is “out of date and misleading,” said strategist Paul Mackel.
Despite its still small share in global trade – 4.3% in 2019, according to the latest data from the Bank for International Settlements – the yuan plays a disproportionate role in the foreign exchange market because its daily movements are fundamental indicators of the sentiment of the global investor. Wells Fargo strategists, including Erik Nelson, argue that the Chinese currency may even be influencing the overall dollar index.
‘Paradigm change’
The offshore yuan may be “taking more weight in the battle for global currency supremacy,” the strategists wrote in a note to customers this month. “If we continue to see signs that the USD / CNH is having more influence on broad dollar movements, this could be a significant paradigm shift in the foreign exchange markets,” they wrote.
However, Beijing’s ambitions to make the yuan a truly global currency still face some real challenges.
The currency’s share of central bank reserves is about 2%, compared to almost 21% of the common currency and just over 60% of the US dollar. It is a woefully low percentage, given the size of China’s economic output. At less than 3%, the renminbi’s share of global payments is only a fraction of its larger rivals, despite increasing use.
But it is the age-old issue of restrictions on the movement of capital across Chinese borders that remains one of the biggest headwinds the currency faces, according to Bipan Rai, head of exchange strategy for the Canadian Imperial Bank of Commerce in Toronto.
“China has made a lot of progress on that front, but it’s still not exactly at the level of free capital flow that you tend to see in other developed markets,” said Rai. “This can be a little distant.”
(Adds details in the 6th and 7th paragraphs to show China’s latest move to relax capital controls.)
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