China’s Stealthy Yuan Support Ebbs, Denting Hedge Fund Trade

A lucrative trade that offered hedge funds a way to ratchet up profits on Chinese debt instruments is starting to lose its charm.
Data due this week may show a popular strategy — which had resulted in a fourfold increase in foreigners’ holdings of Chinese bank notes over the past year — has lost momentum in August, analysts said. 
The trade involves overseas investors lending out their dollars in return for the yuan and using the proceeds to buy short-term bonds. Returns on the strategy have dwindled due to a lower demand for foreign-exchange in the swaps market.
The development is significant because it’s partly due to easing dollar borrowing by Chinese state banks, which had been using foreign-exchange obtained in the swaps market to support the yuan in spot trading. Now with the Chinese currency stabilizing, the need for such a tacit way of intervention has moderated. 
But that’s bad news for hedge funds. China’s short-term bank debt had been a favorite for them — the securities attracted inflows for a record-smashing 11 straight months — even when government and quasi-sovereign notes were losing buyers. It’s likely to narrow investment options for global investors in China as a sluggish economy and geopolitical tensions hurt sentiment in yuan assets. 
“Foreign inflows should have slowed a lot,” said Becky Liu, head of China macro strategy at Standard Chartered Plc. “The bigger risk is the fourth quarter and the first half of 2025. If the trade becomes less attractive when those previous trades mature, the portion being rolled over is likely to be smaller.”
One-year dollar-yuan swap points surged the most since 2008 in August and stayed elevated since then, suggesting returns from lending the greenback in return for the Chinese currency have slumped. 
Last month, overseas investors lent out $1 billion of foreign-exchange with one-year swaps, significantly lower than the amount seen previously, according to two traders. State banks shifted from being net borrowers to lenders of dollars, they added. The traders asked not to be identified as the information was private. 
On top of fading intervention by state banks, bets that the Federal Reserve will start slashing interest rate as soon as this week have also contributed to the shift.
Before the such a move, Fed’s rate hikes and Chinese state banks’ efforts to bolster the yuan sent one-year swap points to the lowest since the global financial crisis.
In July, overseas investors bought a net 118 billion yuan of NCDs, or negotiable certificates of deposit, boosting their holdings of the debt to a record 1.1 trillion yuan, according to the latest data from the Shanghai Clearing House.
The one-year yield on AAA rated bank bonds climbed to a two-month high at the end of August before easing. The offshore yuan was little changed at 7.10 on Monday.
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