Fading Charm: How China’s Stealthy Yuan Support Shifts, Impacting Hedge Fund Trade on Chinese Debt Instruments

Support for China's discrete yuan lessens, impacting popular hedge fund deal

A profitable deal that facilitated hedge funds in increasing their earnings on Chinese debt tools is beginning to lose its appeal, according to analysts.

A profitable business that provided hedge funds an opportunity to increase earnings on Chinese debt securities is beginning to lose its appeal.

Analysts predict that information expected to be released this week could indicate a slowdown in August for a widely-used tactic, which previously led to a quadrupling of foreign investors' possession of Chinese bank notes over the prior year.

The transaction consists of foreign investors loaning their dollars in exchange for the yuan, and then utilizing the resulting funds to purchase short-term bonds. Profits from this approach have declined because of a decrease in demand for foreign currency in the swaps market.

The progress is important as it's partially attributed to Chinese state banks lessening dollar loans, which they had been sourcing from foreign-exchange in the swaps market to uphold the yuan in spot trading. Now that the Chinese currency is steadying, the requirement for this subtle method of intervention has lessened.

However, this poses a problem for hedge funds. Short-term bank debt in China was once their preferred choice – these securities drew investments consistently for an unprecedented 11 consecutive months – even amidst a decline in interest for government and quasi-sovereign bonds. This scenario is expected to limit investment alternatives for international investors in China, as a slow economy and geopolitical conflicts negatively impact the perception of yuan assets.