Yuan Gains on Yen in Carry Trade Shift

The Chinese yuan is gaining traction as a potential funding currency for global carry trades, fueled by expectations of a Bank of Japan rate increase that's lifting the yen. Strategists at major financial firms, including Citigroup and Maybank, have highlighted the yuan as a viable alternative to the yen in carry trades.

The yen has long been a popular choice for funding carry trades due to low interest rates in Japan. However, with rising expectations of a rate hike by the BOJ, the yen's attractiveness is waning, and its strength is undermining the profitability of yen-funded carry trades.

A strategy that borrows offshore yuan and invests in eight emerging-market currencies returned 1.5% over the past three months, outperforming a similar strategy funded in yen by 0.5%. The increased stability of the yuan's interest rates and lower volatility have made it an attractive choice for carry trades.

Citigroup noted that offshore yuan has become more appealing as a funding currency due to improving carry returns relative to volatility. However, some experts caution that the yuan may struggle to fully replace the yen as Asia's main carry-trade funding currency due to its limited liquidity in long-term funding markets and lack of free convertibility.