A significant shift is underway in currency markets as confidence in the Chinese yuan grows, sharply reducing the price for investors to protect themselves against potential US dollar losses. The cost for mainland investors to hedge has now dropped to its lowest point in three years, signaling a major change in sentiment.
Forward Contracts Signal Strong Yuan Confidence
Data compiled by Bloomberg reveals that dollar-yuan forward contracts now imply investors can lock in a 12-month settlement rate near 6.86. This figure is approximately 1.7% below the current spot rate and sits close to the lowest level observed since August 2022. This marks a dramatic decline from the middle of 2024, when the hedging cost was as high as 4%.
This drop coincides with a robust rally for the yuan, which has strengthened by 5% over the past twelve months. A key psychological milestone was crossed last month when the currency breached the 7 per dollar threshold for the first time since May 2023. Analysts point to several driving forces behind this strength:
- Broad weakness in the US dollar.
- China's expanding trade surplus.
- Signs of an improving domestic economy.
- The People's Bank of China's (PBOC) apparent willingness to allow appreciation.
- Seasonal inflows ahead of the Lunar New Year.
Hedging Activity and Central Bank Role Intensify
Fiona Lim, a senior strategist at Malayan Banking Bhd. in Singapore, notes, "There was a strong bullish yuan momentum trade into year-end and the fact is that bullish seasonality factors that had played a part in this could persist into the Spring Festival. Exporters may continue to hedge against yuan gains given the current sentiment."
This sentiment is reflected in market activity. Traders at onshore banks, who requested anonymity, report increased client demand for forward foreign-exchange settlement and dollar-yuan put options since December. To manage their derivative positions, these banks sell dollars in the spot market, an action that further supports the yuan's value.
The People's Bank of China has actively contributed to this trend in recent months by setting steadily stronger daily reference rates for the yuan. This consistent trajectory has given traders confidence that Chinese officials are comfortable with further appreciation, which is also seen as a move to ease tensions with trade partners.
Data Confirms Surge in Corporate Hedging
Official statistics from China's State Administration of Foreign Exchange (SAFE) confirm the pickup in hedging. Banks signed a total of $109.8 billion in foreign exchange forward settlement contracts in the three months through November. This is the highest volume on a rolling basis since June 2023.
Furthermore, SAFE data shows exporters are accelerating their conversion of US dollars into yuan. In November, onshore banks acted as net sellers of foreign exchange for their clients for the ninth consecutive month.
Despite the recent gains, analysts like Thomas Mathews, head of Asia Pacific markets at Capital Economics in London, believe the upward pressure remains. In a client note published last week, he wrote, "There's still plenty of pressure for the yuan to strengthen despite its recent gains," indicating that the current market dynamics may have further to run.
