Forex Investment and Currency Trading

We have had a massive unwind of short US dollar / long RMB positions from the hedge fund community given the slower pace of the RMB appreciation from the People’s Bank of China (PBOC).  The positions have been exited as a result of the general US dollar rally versus the EUR and GBP over the past week which has prompted a US dollar rally against most currencies and the fact the PBOC slowed its appreciation to only 0.50-0.75% in the month of April.  For your guide, we averaged 1.5% appreciation from November 2007 through March 2008.

Overall, this should be a great opportunity to hedge your short RMB exposure for two key reasons:

• The PBOC will be forced to re-accelerate the pace of RMB appreciation given the lack of other instruments it can use to curb inflation.  Our economists forecasts another 9% of appreciation over the next year (assuming China maintains 10% GDP growth). 
• The current NDF only implies an appreciation of 5.7% over the next year.  We are at the cheapest levels to hedge a short RMB exposure for several months.  This opportunity will not last very long.

Hedging USD/RMB Risk 

The pace of RMB appreciation has accelerated significantly

• In July 2005, The People’s Bank of China (PBOC) broke its long held USD peg.  For the first year, the RMB only appreciated 3.6%.  The pace picked up in the 2nd year and RMB appreciated 5.59%.  The pace accelerated significantly in November 2007 (was on pace for 15-16% appreciation over the next year) but has slowed remarkably in April 2008.
• Since the PBOC de-pegged its currency, RMB has appreciated 18.4%
• Although RMB is a heavily restricted currency, the non-deliverable forward market (NDF) is very liquid for any tenor under 2 years.  According to the Bank of International Settlements (BIS), the daily average turnover in the USD/RMB NDF market is $9.0bn…up from only $1.0bn in 2004.
• The current NDF market implies RMB will appreciate to 6.59 over the next year, or just another 5.7% from today’s spot rate.  Market forecasts for the next year has RMB appreciating to 6.38 – more than 8.9% appreciation (strong view that RMB will appreciate between 8-12% each year)
• The pace of CNY appreciation has outpaced (appreciated more) than what the NDF curve has implied nearly every time over the past year (by a significant margin in February – March)
• Given the significant amount of risk that the company has, it is recommended to hedge this exposure with a forward contract given the unique opportunity of only 5.7% appreciation being priced into the market right now.

Price Indications for NDF Contracts

• The PBOC has slowed the pace of the RMB appreciation to around 0.75% per month in April after having several months in a row of 1.50% appreciation on average (November 2007-March 2008)
• The slowing of the RMB appreciation has forced the leverage community (hedge funds) to exit short US dollar vs. long RMB trades.  The unwinding of these trades has provided a unique opportunity for US Companies with manufacturing and other local costs to hedge its exposure
• Historically, the NDF curve was essentially prohibitively expensive to hedge a short RMB exposure as the market has implied as much as 16% appreciation over 1 year
• Given the current environment though, companies have a unique opportunity to purchase RMB over 1yr with only 5.7% appreciation priced into NDF.  So take advantage and lock in hedges.

NDF Indications – May 8, 2008

NDF Indications – April  10, 2008