Carry Trade: Japanese Yen Falls, Chinese Yuan Rises

As Japan ends its negative interest rate policy and Taiwan raises its rates, the Chinese yuan has recently gained attention as a carry trade currency.

On the 24th (local time), Bloomberg reported that the yuan's appeal as a funding currency for global emerging market carry trades is increasing.

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Carry trade is an investment strategy where money is borrowed from countries with low interest rates and invested in countries with higher yields to generate profits. Ideal carry trade currencies have low volatility and limited upside potential. The Japanese yen, which had maintained negative interest rates, was a representative carry trade currency.

However, the mood has changed as Japan ended its negative interest rate policy for the first time in eight years. The Bank of Japan (BOJ) announced on the 19th at its monetary policy meeting that it would lift the negative interest rate policy and raise the short-term interest rate target to 0?0.1%. Although the yen remains one of the lowest interest rate currencies globally even without negative rates, Bloomberg explains that its attractiveness has diminished due to increased upside potential and volatility.

Taiwan's carry trade appeal is also declining as its interest rates have reached the highest level since 2008. The Central Bank of Taiwan surprised markets on the 21st by raising the benchmark interest rate by 0.125 percentage points to 2.00%.

On the other hand, the yuan is analyzed to have almost no room for appreciation this year due to China's economic slowdown. On the 22nd, the People's Bank of China set the dollar-yuan reference exchange rate at 7.1004 yuan, marking the largest depreciation of the yuan in over two months. Bloomberg explains that this indicates Chinese authorities are tolerating yuan depreciation.

According to data compiled by Bloomberg, the probability of a yuan interest rate hike within the fourth quarter is only 2.28%, lower than that of the yen (8.61%) and the Taiwan dollar (2.48%), and its implied volatility is 4.84%, also lower than the yen (8.45%) and the Taiwan dollar (5.63%).

Brendan McKenna, an emerging markets economist and currency strategist at Wells Fargo, said, "Considering that the People's Bank of China is in a dovish mode amid a challenging growth environment, the yuan could become a primary funding choice."

Olga Yangol, Chief Strategist for the Americas at Cr?dit Agricole, commented on the yuan, saying, "It doesn't seem likely to depreciate significantly, but if you are looking for a carry trade currency, I think it is absolutely a good choice."

Meanwhile, despite Japan raising interest rates for the first time in 17 years, some analyses suggest that the yen remains attractive as a carry trade funding currency. Although rates were increased, BOJ Governor Kazuo Ueda maintains that the policy remains accommodative. Nicholas Chia, a macro strategist at Standard Chartered, said, "As long as the BOJ keeps rates low, the yen will continue to hold its appeal for carry trades."

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