Global funds have significantly scaled back their purchases of Chinese bank notes in August, marking a notable shift in the trend of foreign investments in China. The cooling of this activity comes as the yuan strengthens and opportunities for profitable swap-based trades diminish.
Purchases of Bank Notes See Sharp Decline
Purchases of negotiable certificates of deposit (NCDs) issued by Chinese banks by foreign institutions slowed dramatically in August. Net purchases amounted to just 28 billion yuan ($4 billion), according to data released on Wednesday. This figure is less than a quarter of the amount bought in July and represents the smallest monthly total since October 2023.
Yuan Strength and Swap Trades Reduce Appeal
Short-term bank notes had become a popular investment vehicle for foreign traders seeking to park their yuan, spurred on by Chinese state banks offering attractive returns via dollar-yuan swaps. Although it’s unclear how much of the recent NCD activity was driven by these swaps, Chinese lenders have amassed swap positions exceeding $100 billion since last year, according to a Bloomberg report.
Support for Yuan Weakening Fades
Earlier in the year, these swap positions played a role in supporting the yuan, which was losing value against the dollar. However, with the US dollar slipping against most Asian currencies this quarter, the necessity for such swap trades has diminished, as traders now expect the US Federal Reserve to lower interest rates.
Diminished Arbitrage Opportunities
Xing Zhaopeng, a senior China strategist at Australia & New Zealand Banking Group Ltd., noted that the reduced pressure on yuan depreciation has shrunk the arbitrage opportunities in NCDs. As a result, Xing predicts that foreign positions in these securities will continue to decline as existing trades mature.
Lower Returns on Yuan NCDs
A trader exchanging dollars for yuan in China’s onshore swap market and investing in one-year NCDs can now expect a return of approximately 4.7%, down from 6% just three months ago. Despite the reduction, the returns remain higher than those on one-year US Treasury bonds, offering some continued incentive for traders.
Yuan Strengthens as Fed Signals Rate Cuts
In August, the yuan appreciated by nearly 2% against the US dollar, marking its best monthly performance in nine months. This rise came as traders increased their bets on an easing of US Federal Reserve policy. On Wednesday, the Fed responded to these expectations by cutting interest rates by half a percentage point, with indications that further reductions may follow in the coming months.
Conclusion
The sharp decline in foreign purchases of Chinese bank notes highlights the evolving dynamics in the global currency and financial markets. As the yuan strengthens and arbitrage opportunities wane, foreign interest in China’s short-term bank notes may continue to cool, especially if the Federal Reserve proceeds with additional interest rate cuts.
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