Taiwan Dollar Overtakes Offshore Yuan as a Carry Trade Currency

The Taiwan dollar is regaining an edge over China’s yuan as a carry-trade currency.

(Bloomberg) — The Taiwan dollar is regaining an edge over China’s yuan as a carry-trade currency.

In the last quarter, borrowing the Taiwan dollar and investing in higher-yielding currencies in the Group-of-10 or emerging Asia led to higher returns on a risk-adjusted basis as measured by the Sharpe ratio. That’s a reversal from the second quarter, based on data compiled by Bloomberg.

The shift came as the People’s Bank of China made it costlier to borrow the yuan in offshore markets in August, as part of its currency defense. China and Taiwan are among the nations with the lowest policy rates in the region, after Japan, as other central banks embarked on aggressive rate hikes to contain inflation. 

“It’s expensive to fund using the offshore yuan given how offshore funding gets squeezed every now and then,” said Christopher Wong, FX strategist at Oversea-Chinese Banking Corp. in Singapore. “From Taiwan central bank’s perspective, it’s not likely they will tighten as inflation is still subdued.”

The three-month rate for banks to borrow the yuan from each other in Hong Kong jumped to as high as 4.48% in September, from 2.72% at the end of June. 

In the second quarter, borrowing the offshore yuan to go long in the Hong Kong dollar and Indian rupee would have led to a Sharpe ratio of around 7 on its carry returns. Using the Taiwan dollar would have delivered a ratio of about 5.

That changed in the third quarter, when going short on the Taiwan dollar and long Asian peers would have led to gains in almost every trade. The offshore yuan was profitable as a carry currency against just the Hong Kong dollar and the Indian rupee in that period. 

That’s due to how the offshore yuan advanced against its peers in the three months ended September, whereas the Taiwan dollar slid.

The Taiwan dollar is an alternative to offshore yuan and the yen as the risk of an intervention from the authorities is relatively low, said Stephen Chiu, FX strategist at Bloomberg Intelligence.

–With assistance from Masaki Kondo and Qizi Sun.

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