Investor interest in U.S. dollar-renminbi (USD/CNH) futures—a trade du jour for currency investors (CME Group data found a 16 percent increase in USD/CNH futures open interest in June 2020 compared to a year previously)—could become a trade de la décennie, according to one macroeconomic expert. Speaking before attendees virtually gathered at the recent Greenwich Economic Forum, Bilal Hafeez, CEO of economic and investment research firm MacroHive, says demand for renminbi-denominated assets is high and heading higher, urged on by China’s ascendance in the global economic landscape, structural changes occurring within the Chinese economy and investor appetite for higher-yielding assets.
Trading in China’s currency—the onshore renminbi (CNY) which is available only domestically, and the dollar-offshore renminbi (CNH)—has seen explosive growth in recent years. Macrohive reports a 19-fold increase in trading in CNY/CNH from 2007 to 2019, based on official trading data from spot, futures and other currency instruments.
So while the currency itself is becoming an increasingly important target for investors, structurally, China has been over-investing over the last 20-30 years, and its savings rate is too high, with gross savings coming close to 45% as a share of GDP.
A Current Account Deficit for China?
Hafeez noted that heading into the Great Financial Crisis in 2007-2008, China’s trade surplus was a gaping 10-11% of GDP. Since then, this proportion has been in steady decline, approaching zero over the last 4-5 years.
If this trend continues, Hafeez says, China could conceivably become a current account deficit country, importing more than it exports, then China could boost its consumption like the U.S. does. That in turn would fortify China even more as an important driver of global growth. In order to achieve this, he says, the Chinese renminbi needs to strengthen, thus reducing the incentive for Chinese producers to focus on exports and instead focus on consumers getting access to cheaper goods, kickstarting growth in consumer spending.
“We think this is something Chinese policymakers are much more open to than before,” he said.
Portfolio flows
Foreign monetary flows into China in recent years reveal that foreign direct investment inflows (companies building, for example, factories in China) have been in decline over the last 5-10 years, Hafeez noted. Instead, portfolio flows—foreign investors buying Chinese bonds and equities–have become much more important.
And this is likely to continue in a global investment environment that is starved for yield.
Besides more support from a policymaker perspective, Hafeez says, from the portfolio flow perspective, what China has to offer are highly attractive bond yields. Bond yields across the globe are trading at low levels, with U.S. bonds yielding 0.5 and 1 percent over last year or so, and currently between 0.7 and 0.8 percent. Japan’s 10-year yield is zero, while German bund yield interest rates are negative, France is negative, and the U.K. is barely positive. But China, the second-largest economy in the world, has interest rates of 3 percent.
“This is incredibly attractive in a world where investors are starved of yield. This is another fundamental reason why we’d expect global investors as a whole to want more and more exposure to the Chinese renminbi,” Hafeez said.
“Another point is central bank reserve allocations – at the moment the dollar is the dominant reserve currency in the world, with reserves allocated to the dollar of 60 percent or so The Euro is next with around 20 percent. [Whereas with] China, central bankers have only allocated 2 percent to the Chinese currency, so we’d expect a lot more allocations to China as the years go on,” he added.
Asian currencies diversify
Hafeez observed that correlations between Asian currencies and the US dollar are low: CNH has a correlation of around negative 20-30 percent with USD, meaning that when the value of the U.S. dollar goes up, the renminbi moves lower, but not in lockstep correlation. The Indian Rupee and South Korean Won, indicating that for a portfolio of dollar-denominated assets, some exposure to Asian currencies serves as an effective diversifier.
The correlation between Asian currencies and U.S. stocks as expressed in the SPX futures market is, again, low, at around 20 percent. CNH has the lowest correlation to U.S. stocks among all Asian currencies, whose correlations are low, anyway.
Additionally, he pointed to recent returns from foreign exchange trading models based on momentum trends (i.e., traders buy at the beginning of an upswing, and sell heading into a momentum downturn). Returns from trend-following strategies in G10 currencies have been relatively weak over the last 3-4 years, particularly from 2018 and onwards. But traders deploying trend following strategies for Asian currencies have seen more stable and positive returns than for the G10.
Hafeez said that investors were better served by seeking exposure to the Chinese renminbi through CNH futures (where SGX is dominant in terms of liquidity and volume), instead of in the OTC market, citing a better track record of liquidity for active investors and a centralized market with clear transparency around price, fees and commission, as well as a better regulatory market for futures compared to OTC markets.
The Singapore Exchange (SGX) has led the world in volume market share for USD/CNH futures since January 2017, he said, and this market is becoming increasingly globalized. He noted that close to 40 percent of volumes in USD-CNH futures is occurring outside the Asian time zones. Investor interest in U.S. dollar-renminbi (USD-CNH) futures—a trade du jour for currency investors—could become a trade de la décennie, according to one macroeconmic expert. Speaking before attendees virtually gathered at the recent Greenwich Economic Forum, Bilal Hafeez, CEO of economic and investment research firm MacroHive, says demand for renminbi-denominated assets is high and heading higher, urged on by China’s ascendance in the global economic landscape, structural changes occurring within the Chinese economy and investor appetite for higher-yielding assets.
Trading in China’s currency—the onshore renminbi (CNY) which is available only domestically, and the dollar-offshore renminbi (CNH)—has seen explosive growth in recent years. Macrohive reports a 19-fold increase in trading in CNY/CNH from 2007 to 2019, based on official trading data from spot, futures and other currency instruments.
So while the currency itself is becoming an increasingly important target for investors, structurally, China has been over-investing over the last 20-30 years, and its savings rate is too high, with gross savings coming close to 45% as a share of GDP.
A Current Account Deficit for China?
Hafeez noted that heading into the Great Financial Crisis in 2007-2008, China’s trade surplus was a gaping 10-11% of GDP. Since then, this proportion has been in steady decline, approaching zero over the last 4-5 years.
If this trend continues, Hafeez says, China could conceivably become a current account deficit country, importing more than it exports, then China could boost its consumption like the U.S. does. That in turn would fortify China even more as an important driver of global growth. In order to achieve this, he says, the Chinese renminbi needs to strengthen, thus reducing the incentive for Chinese producers to focus on exports and instead focus on consumers getting access to cheaper goods, kickstarting growth in consumer spending.
“We think this is something Chinese policymakers are much more open to than before,” he said.
Portfolio flows
Foreign monetary flows into China in recent years reveal that foreign direct investment inflows (companies building, for example, factories in China) have been in decline over the last 5-10 years, Hafeez noted. Instead, portfolio flows—foreign investors buying Chinese bonds and equities–have become much more important.
And this is likely to continue in a global investment environment that is starved for yield.
Besides more support from a policymaker perspective, Hafeez says, from the portfolio flow perspective, what China has to offer are highly attractive bond yields. Bond yields across the globe are trading at low levels, with U.S. bonds yielding 0.5 and 1percent over last year or so, and currently between 0.7 and 0.8 percent. Japan’s 10-year yield is zero, while German bund yield interest rates are negative, France is negative, and the U.K. is barely positive. But China, the second-largest economy in the world, has interest rates of 3 percent.
“This is incredibly attractive in a world where investors are starved of yield. This is another fundamental reason why we’d expect global investors as a whole to want more and more exposure to the Chinese renminbi,” Hafeez said.
“Another point is central bank reserve allocations – at the moment the dollar is the dominant reserve currency in the world, with reserves allocated to the dollar of 60 percent or so The Euro is next with around 20 percent. [Whereas with] China, central bankers have only allocated 2 percent to the Chinese currency, so we’d expect a lot more allocations to China as the years go on,” he added.
Asian currencies diversify
Hafeez observed that correlations between Asian currencies and the US dollar are low: CNH has a correlation of around negative 20-30 percent with USD, meaning that when the value of the U.S. dollar goes up, the renminbi moves lower, but not in lockstep correlation. The Indian Rupee and South Korean Won, indicating that for a portfolio of dollar-denominated assets, some exposure to Asian currencies serves as an effective diversifier.
The correlation between Asian currencies and U.S. stocks as expressed in the SPX futures market is, again, low, at around 20 percent. CNH has the lowest correlation to U.S. stocks among all Asian currencies, whose correlations are low, anyway.
Additionally, he pointed to recent returns from foreign exchange trading models based on momentum trends (i.e., traders buy at the beginning of an upswing, and sell heading into a momentum downturn). Returns from trend-following strategies in G10 currencies have been relatively weak over the last 3-4 years, particularly from 2018 and onwards. But traders deploying trend following strategies for Asian currencies have seen more stable and positive returns than for the G10.
Hafeez said that investors were better served by seeking exposure to the Chinese renminbi through CNH futures, instead of in the OTC market, citing a better track record of liquidity for active investors and a centralized market with clear transparency around price, fees and commission, as well as a better regulatory market for futures compared to OTC markets.
The Singapore Exchange (SGX) has led the world in volume market share for USD/CNH futures since January 2017, he said, and this market is becoming increasingly globalized. He noted that close to 40 percent of volumes in USD-CNH futures is occurring outside the Asian time zones.
