Morgan Stanley Sees Yuan Selloff as SinoPac Barred: China Credit

May 04, 2014 9:35 pm ET

May 5 (Bloomberg) -- Options traders are the most pessimistic on the offshore yuan in almost 10 months as the currency slides and Taiwan cracks down on derivative products.

The premium that investors pay for one-year contracts giving them the right to sell the yuan over options to buy advanced to 2.5 percentage point on April 25, the highest close since July 5, data compiled by Bloomberg show. The rate was at 2.40 last week. The yuan in Hong Kong has dropped 3.2 percent this year as the People’s Bank of China weakened the onshore currency to spur growth in the world’s second-largest economy.

Morgan Stanley is recommending investors stay long on the U.S. dollar against the offshore yuan, saying Taiwanese lenders may sell the Chinese currency after the island’s financial regulator banned Bank SinoPac from selling yuan-linked derivatives. At least four banks cut their forecasts for the onshore yuan immediately after the PBOC doubled the currency’s daily trading band on March 17, following a slump in exports.

“The concern for banks these days is getting headlines that suggest they sold something to corporate clients that didn’t understand them,” Geoffrey Kendrick, Morgan Stanley’s head of Asian exchange-rate and interest-rate strategy in Hong Kong, said in an April 30 phone interview. “It becomes much more probable some structured products will start to be removed by banks.”

Taiwan Punishes

Taiwan’s Financial Supervisory Commission last week banned Bank SinoPac from selling Target Redemption Forwards for a year, saying the lender didn’t fully disclose important product information and risks. It added that it would punish three other banks for such sales. Taiwanese banks account for 25 percent of the $150 billion of TRFs outstanding, Morgan Stanley estimates. Regulators will let Sinopac settle client disputes, Minister Tseng Ming-chung said by phone on April 30.

As much as $25.6 billion of dollar purchases may emerge should the offshore yuan, which was at 6.2567 per dollar last week, fall beyond the 6.30 mark where options kick in, according to Craig Chan, Singapore-based head of Asia ex-Japan currency strategy at Nomura Holdings Inc. Chinese authorities may step in to stabilize the market should offshore trading in the yuan become disorderly, he said.

“It could raise concern that the depreciation in the renminbi is because of real capital flight,” Craig said in a May 2 e-mail interview, using the official name for the yuan. “Given the large stock of speculative capital, it could be extremely destabilizing for all local markets if this happened.”

Yuan Declines

The People’s Bank of China has lowered the onshore yuan’s reference rate by nearly 1 percent against the dollar this year to deter speculators and encourage two-way trading as it seeks to internationalize the currency. The fixing was raised in each of the last eight years after the yuan’s peg to the greenback was ended in 2005. The currency touched 6.2718 per dollar in overseas trading on April 30, the weakest level since October 2012. In the onshore spot market, it has dropped 3.3 percent this year after gaining in each of the last four years.

“The PBOC is tolerating continuing depreciation of the currency to correct the past 12 months or 24 months of short- dollar positions,” Suan Teck Kin, Singapore-based economist at United Overseas Bank Ltd., said in an April 30 phone interview. “It might still go on for at least one or two months.” UOB will probably cut its year-end forecast for the yuan from the current estimate of 6.05 per dollar, he said.

The onshore yuan is forecast to appreciate 3.5 percent by the end of the year to 6.05 against the greenback, according to the median forecast of analysts surveyed by Bloomberg.

China Economy

China’s manufacturing grew less than analysts estimated in April, highlighting weakness in the economy from exports to construction that could force extra government measures to support growth. The Purchasing Managers’ Index was at 50.4, the National Bureau of Statistics and China Federation of Logistics and Purchasing said on May 1, less than the 50.5 median estimate in a Bloomberg survey. March’s reading was 50.3, with numbers above 50 signaling expansion.

Thirty of 31 provinces and municipalities reported missing their growth goals in the first quarter. Exports fell 6.6 percent in March, after plunging 18.1 percent in the previous month. Benchmark borrowing costs have risen, with the yield on China’s 10-year sovereign note up 86 basis points over the past year to 4.3 percent.

Trade Surplus

Taiwan banks began taking yuan deposits on the island in February 2013 and underwriting debt in the currency after a clearing agreement was signed in 2012. Last year, Taiwan had a trade surplus of $116 billion with China, its largest trading partner, an increase of more than 50 percent from the $75.1 billion excess in 2012.

About 1.5 billion yuan ($239 million) of Formosa notes were sold in Taiwan this year, data compiled by Bloomberg show. Only nine of the 15 bonds sold in the market’s debut year traded in the secondary market in the first two months of 2014, according to GreTai Securities Market, the main exchange.

Growth in yuan deposits held by Taiwanese banks, including their offshore banking units, eased to 8.6 percent in March from the previous month compared with a 15 percent increase in February, according to latest central bank data. This is partly because of the yuan’s depreciation, said Chung Hsu, a Taipei- based banking analyst at Credit Suisse Group AG.

Taiwan regulators are “using this opportunity to tell banks to be cautious with yuan derivatives,” Hsu said by phone on April 30. “If the yuan continues to fall, there will be forced exits by design of the products, so as a result there’ll be unwinding.”