China’s stealthy yuan support ebbs, denting hot hedge fund trade

A lucrative trade that offered hedge funds a way to ratchet up profits on Chinese debt instruments is starting to lose its charm.

Data due this week may show a popular strategy – which had resulted in a fourfold increase in foreigners’ holdings of Chinese bank notes over the past year – has lost momentum in August, analysts said.

The trade involves overseas investors lending out their dollars in return for the yuan and using the proceeds to buy short-term bonds. Returns on the strategy have dwindled due to a lower demand for foreign-exchange in the swaps market.

The development is significant because it is partly due to easing dollar borrowing by Chinese state banks, which had been using foreign-exchange obtained in the swaps market to support the yuan in spot trading. Now with the Chinese currency stabilising, the need for such a tacit way of intervention has moderated.

But that is bad news for hedge funds. China’s short-term bank debt had been a favourite for them – the securities attracted inflows for a record-smashing 11 straight months – even when government and quasi-sovereign notes were losing buyers. It is likely to narrow investment options for global investors in China as a sluggish economy and geopolitical tensions hurt sentiment in yuan assets.

“Foreign inflows should have slowed a lot,” said Becky Liu, head of China macro strategy at Standard Chartered. “The bigger risk is the fourth quarter and the first half of 2025. If the trade becomes less attractive when those previous trades mature, the portion being rolled over is likely to be smaller.”