Latest / International Business with Fexingo: Global Trade, Cross-Border Deals, and Multinational Operations / How the Yuan Carry Trade Is Reshaping Global Finance
Transcript
- Lucas: Luna, you know how everyone has been fixated on the yen carry trade and whether it's coming back? There's another carry trade quietly building in plain sight, and it involves a currency nobody thinks of as a funding vehicle. Luna: You mean the yuan? Lucas: Exactly. The renminbi. China's ten-year government bond yields around 2.8 percent right now. That's down from 3.1 percent a year ago. Meanwhile, India's ten-year bond is yielding roughly 7 percent. Brazil is north of 12 percent. So you borrow cheap yuan, convert it into dollars or directly into rupees or reais, and pocket the spread. Luna: That spread is pretty juicy. But isn't the yuan tightly controlled? How do you actually short it? Lucas: You can't short it the way you short the yen or the euro in the open market. But there are offshore deliverable forwards and nondeliverable forwards in Hong Kong and Singapore. Hedge funds have been using those to effectively borrow yuan at offshore rates, which are actually lower than onshore rates right now because of capital outflow restrictions. Luna: So the PBOC's capital controls are making the carry trade cheaper? That's ironic. Lucas: It is. The offshore CNH market has its own liquidity pool. When Beijing tightens capital outflows, offshore yuan becomes more abundant relative to demand, pushing offshore rates down. That's exactly what we've seen since late 2025. The offshore yuan swap rate for three months is around 2.5 percent. That's a full percentage point below where it was two years ago. Luna: And on the other side of the trade, emerging market bonds have been rallying. The EEM ETF is up over 4 percent in the last five days alone. Lucas: Right. EEM hit 68.60 as of this morning. That's a 4.1 percent gain in a week. A lot of that is carry-driven. Investors are chasing yield anywhere they can find it, and the yuan is becoming the new funding currency of choice. Luna: How big is this trade, roughly? Any estimates on volume? Lucas: Hard to get exact numbers because a lot of it happens offshore and off-balance-sheet. But Bloomberg noted in April that outstanding nondeliverable yuan forwards had grown to about $80 billion notional, up from $55 billion a year earlier. A significant chunk of that is carry trades. Luna: And the risk? What could blow it up? Lucas: The biggest risk is a sudden yuan appreciation. If the PBOC decides to let the yuan strengthen—say, to unwind trade tensions or to fight imported inflation—carry traders would get crushed on the currency leg. Even a 2 percent move against you could wipe out the entire yield pick-up. Luna: Or if Beijing slaps new capital controls that make it impossible to roll over the forwards. Lucas: Exactly. That's the second-biggest risk. The trade works as long as liquidity remains fungible. If the PBOC starts cracking down on offshore derivative positions—which they've threatened before—the whole thing could freeze up. Luna: So is this a trade for retail investors, or is it strictly institutional? Lucas: Strictly institutional for now. The minimum contract sizes on offshore yuan forwards are typically one million dollars equivalent. But some ETFs are indirectly exposed. The iShares China Large-Cap ETF, FXI, has a lot of Chinese state banks that fund themselves in yuan. If the carry trade drives down offshore rates, those banks benefit. But it's a very indirect play. Luna: It's fascinating how a currency that's supposed to be controlled is becoming a global funding tool. It's like the yen in the 2000s, but with more state involvement. Lucas: Exactly. And that tension—between Beijing wanting a stable, internationalized yuan and also wanting capital controls—is what makes this trade both lucrative and fragile. If you're a macro fund, you have to watch every PBOC statement like a hawk. Luna: Speaking of watching closely—if these kinds of conversations help you think about your portfolio or your work, you might want to know that listener support is what keeps this show ad-free and independent. It's a small thing that makes a big difference for us. Lucas: Yeah, we don't run ads, and we want to keep it that way. If you find value in the episodes, you can support the show at buy me a coffee dot com slash fexingo. No pressure, just if it works for you. Luna: And back to the yuan carry trade—one thing I'm watching is the trade-weighted dollar index. It's at 119.3, down slightly from 119.37 a week ago. A weaker dollar actually helps the carry trade because it reduces the dollar strength that could offset emerging-market gains. Lucas: Good point. The dollar has been softening a bit, which gives EM central banks room to keep rates high without worrying as much about currency depreciation. That's exactly the environment where carry trades flourish. Luna: So what's your call? Is the yuan carry trade going to keep growing, or is the PBOC going to step in? Lucas: I think it grows for another quarter or two. The PBOC is more focused on stimulating domestic growth than on cracking down on offshore derivatives right now. But once the trade gets too big—say, above $150 billion notional—they'll start to worry about financial stability and they'll tighten. That's when you want to be out. Luna: So the play is to ride it while the PBOC looks the other way, but keep the exit door open. Lucas: Exactly. It's a classic 'don't fight the central bank' trade—except the central bank hasn't decided to fight yet.