Foreign Currency

Yuan Short Sellers Risk Getting Burned on China Stocks Rescue

(Bloomberg) — The yuan looks set to become a key beneficiary of China’s plan to stem a stock-market rout, as the equities rescue package would exacerbate a scarcity of the currency overseas, putting a squeeze on short-sellers.

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The offshore yuan will extend gains after posting its biggest advance in two weeks on Tuesday, according to Mizuho Bank and Malayan Banking Berhad. The banks expect offshore yuan liquidity to tighten with Beijing said to be considering 2 trillion yuan ($278 billion) of onshore stock purchases mainly from the overseas accounts of state-owned enterprises to stem a selloff.

Such a move will be an added boost to the offshore yuan, which is already being supported by a sharp increase in its funding costs in Hong Kong’s interbank market thanks to speculations of policy support for the currency and seasonal factors. The offshore unit rebounded nearly 1% since slumping to the weakest since November last week.

“The stock rescue plan kills two birds with one stone,” said Zhaopeng Xing, senior China strategist at Australia & New Zealand Banking Group Ltd. It helps the stock market in the short run, while directing capital from offshore to onshore and supports the yuan to some extent, he added.

Stability in the foreign-exchange market has become crucial for policymakers as any rapid decline in the yuan could lead to capital outflows and worsen investor sentiment that’s already being hurt by the equities selloff. A stronger currency also gives the central bank more leeway to ease its monetary policy to effectively stimulate the economy.

Both foreign-exchange and rates markets are flashing signs of liquidity tightness. A gauge tracking the offshore yuan’s overnight funding cost in the forwards market climbed for a third straight session on Wednesday, while an indicator of the currency’s interest rate in Hong Kong rose across the curve on Tuesday.

“The stabilization fund that works by using the offshore funds to buy mainland shares would technically tighten offshore liquidity,” driving the rates on yuan higher in Hong Kong, said Fiona Lim, a senior currency strategist at Malayan Banking Berhad in Singapore. The yuan will advance to 7.1 per dollar by the end of June, she said.

On top of the rescue plan, the yuan will also be buoyed by an expected weakness in the dollar due to a Federal Reserve policy pivot and the Chinese central bank’s support for the currency with its daily reference rates. The average spread between the so-called fixing, which limits the onshore yuan’s moves by 2% on either side, and a Bloomberg estimate has nearly doubled this month compared with December.

The offshore yuan fell 0.1% to 7.1762 per dollar on Wednesday, after gaining in the previous four sessions.

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