Oftentimes, investors ask where the Chinese yuan fits in their portfolio. The volatility of the Chinese yuan is definitely being managed, given that China maintains a 1.00% daily trading band on its currency.5 In fact, since August 20056 volatility in non-deliverable forward currency contracts (“forwards”) has averaged 1.97% per year.7 Over the past year, amid concerns of slowing Chinese economic growth, expectations for an appreciation of the Chinese yuan have faded. However, this has created a different opportunity in the market. From 2005 to 2011, foreign investors trying to position themselves for an appreciating yuan were limited to investments in forwards. This “one-way” trade at times became “crowded,” resulting in forwards failing to completely capture movements in the spot currency. Now that appreciation expectations have moderated and investors have multiple means of accessing yuan investments, the market is providing positive interest rates for investors waiting for appreciation. As of October 31, 2012, the implied interest rate on 12-month forwards was 2.11%, over seven times the rate of 2-year U.S. Treasury bonds.8
Given the current level of U.S. interest rates, investors’ positions in short-term U.S. fixed income have limited return potential. With comparable levels of volatility, it could make sense for some investors to invest a portion of their assets in vehicles that offer exposure to the Chinese yuan. Historically low levels of volatility, positive exposure to upside surprises in Chinese gross domestic product (GDP) growth, and positive interest rate carry all support the case for increasing investor allocations to the Chinese currency, where suitable.
Rick Harper serves as the Head of Fixed Income & Currency for WisdomTree Asset Management.
1Bloomberg, 2012.
2World Bank, 2012.
3The policies were announced September 24, 2012, in China’s 12th Five-Year Plan.
4“China Unveils Financial Reform Plan for 12th Five-Year Plan Period,” Xinhua News Agency, September 24, 2012.
5On April 16, 2012, the Chinese government loosened the intraday trading band on the Chinese yuan, allowing the currency to vary within a 1.00% daily trading band, compared to the previous 0.50% band.
6China has allowed the yuan to fluctuate against a basket of currencies since July 21, 2005.
7JPMorgan, October 31, 2012.
8Bloomberg, 2012.