Ever since China shocked markets with a surprise devaluation of its currency in August 2015 speculation has built that the move was a precursor to a much larger state-sponsored weakening of the Yuan.
That was because the weakness in the Yuan came at a time when the Chinese economy was clearly slowing. Traders and investors started to bet that the Yuan would fall further.
Consequently some of the world’s most prominent hedge fund managers – Kyle Bass, Stanley Druckenmiller, David Tepper, and David Einhorn – all positioned for a big move higher in the USDCNY rate as the Yuan weakened. (Higher USDCNY reflects a stronger US dollar and a weaker Yuan).
But Bloomberg reports this morning that the “battle over the fate of China’s currency is starting to get bloody for the bears”.
That’s because the PBOC has been active in the official and unofficial markets for the Yuan – basically, buying the currency – and the exchange rate is back under 6.50.
“At least $562 million of options that pay out if the currency drops below 6.6 per dollar — its weakest point since the devaluation — have expired worthless since August. Another $807 million will lapse within three months,” Bloomberg said.
The expiration of these options – derivative contracts allowing the hedge funds to profit from their expectations of a weaker Yuan – means the cost hedge funds paid for the options – the premium – has been lost as Chinese authorities have shown a determination to keep the Yuan stronger than many market players expected.
The question for the shorts – those hedge funds betting against China and the Yuan – is whether the PBOC or the China’s authorities will give ground any time soon.
Hilmi Unver, head of alternative investments at Notz Stucki & Cie which has allocated $3 billion to hedge funds, told Bloomberg “China wants to have control over the yuan and will do whatever it can to ensure that no one else decides what direction it goes in.”
“Is it worth fighting against a huge economy and policy maker that could take you out? No,” he added.
The question for the hedge fund community is whether to take Unver’s advice.
You can read the original Bloomberg story here.
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