(Bloomberg) — Chinese companies may be tempted to sell off $1 trillion of dollar-denominated assets as the U.S. cuts interest rates, a move that could strengthen the yuan by as much as 10%, according to Stephen Jen.
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Eurizon SLJ Capital CEO said currencies are now the biggest risk that is not properly priced into markets, and the yuan could play an outsized role in this.
“Think of an avalanche,” Jen said of the impact of the repatriation flows. The yuan “will rise and will probably be allowed to rise — five to 10 percent would be modest and acceptable to China.”
The theory goes like this: Chinese companies may have amassed more than $2 trillion in offshore investments since the pandemic, parked in assets that pay higher rates than yuan-denominated assets, Jen said. As the Federal Reserve lowers borrowing costs, the appeal of dollar assets will diminish, potentially fueling a “conservative” $1 trillion in flows back home as China’s interest rate discount with the U.S. narrows.
Jen, known for his work on the “dollar smile” theory, predicts that the Fed will cut rates more aggressively than markets expect if U.S. prices continue to fall. That, combined with an overvalued dollar, America’s twin deficits and prospects of a soft landing, reinforces his belief that the dollar will fall.
The end result is a Chinese currency that could well move higher against the greenback, which was trading around 7.12 per dollar on the onshore market on Monday, after weakening to nearly 7.28 in July.
The rally could be even bigger if the People’s Bank of China does not step in to soak up dollar liquidity, London-based Jen said in an interview last week.
The case for the yuan to rise now appears even stronger after Fed Chairman Jerome Powell said at the symposium in Jackson Hole on Friday that it is time for the US to cut its policy rate.
But such a move is unlikely to happen immediately after the first Fed cut. It could happen if the dollar’s decline accelerates in a so-called soft landing scenario, or if U.S. inflation eases without triggering a recession, Jen said.
Yuan pressure
His view is consistent with that of Guan Tao, a leading economist at Bank of China International Ltd., who has said the yuan could rise if a scenario similar to the collapse of the yen carry trade plays out.
The fallout from the yen’s unwinding was so profound that it rippled across everything from stocks to credit to emerging currencies. A crash in the yuan-financed carry trade — where traders borrow the currency cheaply and sell it for higher-yielding alternatives — could unleash fresh waves of panic, particularly in Asian markets.
Still, the PBOC can smooth out wild swings, Jen said. Beijing has always been cautious about aggressive gains in the yuan, as it could hurt export competitiveness and undermine an already sluggish economic recovery.
China’s currency watchdog is already on guard as it assesses the impact of a stronger yuan on exporters, insiders said. And some strategists have argued that carry trades targeting a weak yuan still make sense given China’s mixed economic fundamentals.
The PBOC also has plenty of measures to manage market expectations. Recently, it has used tools to promote currency stability, such as the daily reference rate for the onshore yuan and adjustments to the amount of foreign currency deposits that banks must hold as reserves.
Moreover, despite the gradual contraction that has occurred in recent times and the gap between Chinese and US interest rates, companies are unlikely to sell their foreign currency investments for the time being.
Others estimate the amount of cash in Chinese businesses to be somewhat lower than Jen.
Macquarie Group Ltd. estimates that Chinese exporters and multinationals have amassed more than $500 billion in dollar holdings since 2022. Australia & New Zealand Banking Group Ltd. puts the figure at $430 billion.
“The pressure will be there” for the yuan to rally, Jen said. “If we just assume that half of this amount is the money that is ‘footloose’ and easily provoked by changing market conditions and policy, then we are talking about $1 trillion of fast money that could be involved in such a potential stampede.”
–With assistance from Qizi Sun.
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