Speculators Start Sniffing the Yuan

After Washington's mid-term elections, some are wondering if a tough move on China is in the offing, writes Standard Chartered economist Stephen Green

by Stephen Green

The Chinese currency speculators are back. Not in full force maybe, but the last few weeks, after a very quiet summer, there has been a pickup in both buzz and trading activity regarding the yuan. Some international investors, long bored with the outlook for the currency, seem to be taking another look.

If there ever was a barometer for speculation about China's currency, it is the non-deliverable forward (NDF) market. An NDF is simply a contract to buy the yuan at anywhere from one week to several years into the future. You buy a "one-year forward" if you think the currency will be worth more than the price of the forward at that time.

Mainland companies do not usually get to play since the NDF markets are offshore, so the market is generally made up of speculators and foreign companies doing business in or with China who feel the need to hedge their currency exposures.

Appearance of Political Pressure

Over the last few days, NDF prices have been moving—from estimating the yuan will be 7.62 against the dollar in a year's time at the end of October, to 7.52 the last week of November. This suggests that speculators are betting again that the Chinese currency will appreciate more rapidly than before.

What is going on? Certainly there is the appearance again of political pressure coming from overseas. The Democratic Party's mid-term election win in the U.S. has got some thinking that Washington is going to get really tough with One statistic to back the widespread feeling of unease among U.S. workers is that the average family now faces a 17% chance of losing 50% or more of its income vs. only 7% 30 years ago.

China is an easy scapegoat for the painful restructuring that an already-rich economy needs to go through. New York Democratic Senator Charles Schumer, infamous for his draft bill to push Beijing to appreciate its currency via the threat of tariffs on Chinese imports, is the new chairman of the Senate's Joint Economic Committee.

Looking for a Return

Add to that the first meeting of the U.S.-China Strategic Economic Dialogue (SED) will be held on Dec. 14 and 15 in Beijing, around which Treasury Secretary Hank Paulson will be having more senior-level meetings.

The SED was designed to broaden focus beyond such currency issues, but of course the subject is hard to ignore. And on the other side, with yearend in sight, some hedge funds seem to be willing to take another punt at the NDF market, looking for return after a year's worth of low returns and low market volatility. Since September, the average pace of yuan appreciation has picked up a smidgeon.

A final factor in pushing the NDF market territory further has been a change in the market rules in It has always been illegal for mainland banks and companies to trade NDFs. But it seems to have been going on. And four weeks ago, the State Administration of Foreign Exchange (SAFE) restated its ban on such activities.

Moderate Appreciation

This prevented those institutions from trading NDFs (which they were doing, along with trading the onshore forward market, arbitraging the two curves). Stopping that trade meant fewer players in the NDF market and that has helped pushed NDF down as well.

So what is really going on? There hasn't been much change in the tone or direction of the debate in China on the yuan question. The recent pickup in the speed (from glacial to gradual) of Chinese currency against the dollar is partially explained by the fact that China now has a decent FX market infrastructure and the continued strong export growth has strengthened the cause of those who argue that moderate appreciation should have little impact on export dynamism.

The People's Bank of China, the central bank, continues to argue for stronger action to resolve the current imbalances. Standard Chartered forecasts China's current account surplus in 2006 to hit $217 billion, over 8% of GDP. However, other bits of government remain skeptical.

Still on the Back Burner

There is also the question of whether Washington has much leverage over Chinese currency policy.