Dollar losing allure for Chinese traders creates runway for yuan

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Dollar losing allure for Chinese traders creates runway for yuan.

foreign exchange :: 1day ago :: source - bloomberg

By Bloomberg News

(Bloomberg) — Chinese traders are pulling back from the dollar, helping ease a shortage that has rattled the banking system and setting the yuan up for further gains.

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The dollar’s premium over the yuan, as reflected in 12-month swap points, has narrowed by 25% since the end of December. Chinese state-owned banks have gradually shifted from wanting dollars to reducing their demand for it, to offering it out, according to traders who declined to be identified as they’re not authorized to speak publicly.

The change underscores how a shift in the dollar’s fortune — it posted a 10.7% slide in the first six months as Donald Trump’s tariff and fiscal policies fueled uncertainty — is easing the pressure on the Chinese yuan. That’s giving Beijing room to ease up on their efforts to support the currency.

“The swap points reflect decreasing demand for the dollar as well as optimism toward the room for yuan to strengthen,” said Hao Zhou, chief economist at Guotai Junan Hong Kong Ltd. Swaps might have also gained support from easing expectations of interest-rate cuts in China amid upbeat economic data, he said.

Foreign-exchange swaps have surged in popularity in China’s tightly controlled financial system. More companies and banks now use them to hedge risks and manage dollar holdings for operations or investment needs.

State-owned banks have been major players, using swaps to defend the yuan — borrowing dollars and selling them back at maturities. At their peak, these swap positions exceeded $100 billion and attracted offshore hedge funds into profitable trades involving Chinese short-term debt.

By borrowing dollars to buy yuan via swaps trades, Chinese banks essentially supported the yuan exchange rate, while foreign investors gave the Chinese banks dollars and got the equivalent in the yuan to invest in the local bond market.

Chinese state-owned banks had been cutting their greenback borrowings via one-year swaps since the second quarter, according to traders. They’re now offering short-term greenback via swaps, and that may also dampen foreign appetite for banks’ negotiable certificate of deposits.

From a market pricing perspective, swap points tend to shrink when the interest rate outlook between the US and China starts to align. That possibility has grown stronger, with markets anticipating a Federal Reserve rate cut in September and China’s recent economic data exceeding expectations — strengthening the belief the People’s Bank of China (3988.HK) can afford to delay further easing.

The PBOC set the yuan’s reference rate at 7.1475 per dollar on Friday, the strongest level since November even as the greenback advanced. Global banks, including Goldman Sachs (GS) and Morgan Stanley (MS), recently forecast a modest gain for the Chinese currency toward 6.9 to 7.1 yuan per dollar in the next 12 months.

Citigroup Inc. (C) strategists highlighted that foreign-currency deposits in China are now at around a three-year high, suggesting dollar reserves are ample. Some companies may have repaid foreign-currency loans, allowing banks to accumulate more dollars, strategists Rohit Garg and Philip Yin wrote in a recent note. And these larger deposit pools often coincide with rising dollar-yuan swap points.

Looking ahead, analysts expect dollar-yuan swaps to rise further.

Citigroup is forecasting that 12-month swap points will climb from the current -1,866 pips to -1,500 pips in the coming months, a level last seen in early 2023.

Guotai Junan’s Zhou echoed this forecast, contingent on the Fed kicking off rate cuts.

(Updates with PBOC yuan fixing in the 10th paragraph.)