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China Yuan's Best Q3 Since 2008: ETFs to Benefit/Lose

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The Chinese yuan has lately been gaining credibility as a safe haven from volatility as it recorded its best quarter in 12 years. The onshore renminbi gained about 4% in the third quarter, the most since early 2008, while its offshore counterpart made a move of more than 4%. That has beaten returns from traditional Group-of-10 refuges like the Swiss franc and Japanese yen.

Invesco CurrencyShares Japanese Yen Trust (FXY - Free Report) and Invesco CurrencyShares Swiss Franc Trust (FXF - Free Report) were up 1.7% and 2.6% in the past three months, respectively. Another safe haven currency U.S. dollar ETF Invesco DB US Dollar Index Bullish Fund (UUP - Free Report) lost about 3.6% in the past three months (as of Oct 1, 2020). WisdomTree Chinese Yuan Fund( (CYB - Free Report) has gained 5.8% during the same time frame.

Yuan’s Surprise Journey in the Past Five Years

The latest trend in yuan is quite surprising as devaluation in the currency was a hot financial event in August 2015 that caused a market bloodbath. The month of August 2015 is remembered in the financial world for China's yuan devaluation by about 2%.

The step, taken on Aug 11, shook the global markets and almost all asset classes as yuan posted the largest single-day decline since the historical devaluation in 1994, after the country arranged its official and market rates in a line. Notably, the Chinese authorities follow a trading band around the official reference rate it sets each day for the value of the yuan against the dollar.

China’s central bank defended its currency intervention “as a free-market reform,” but the move was criticized by U.S. lawmakers and viewed as a means of taking undue favor in exports. However, since then, several changes have taken place on the global economic front. In fact, the fund CYB has actually strengthened more than 5% in the past five years (as of Oct 1, 2020).

Trading in the currency yuan jumped 41% between 2016 and 2019, “with a snapshot of turnover taken by the Bank for International Settlements last April, showing that an average $285 billion-a-day changed hands, just behind volumes in the Swiss currency,” per a Bloomberg article. Global reserves in the Chinese currency have increased to 2.1%, up from 1.4% two years ago.

Why the Latest Rally?

Despite being the epicenter, China’s success in controlling the coronavirus and its adverse economic consequence has fetched both praise and investments, and strengthened the market assumption that the yuan could become a new refuge for the risk-averse, per the Bloomberg article.

The article went on to highlight that China is set to be the only major economy to expand this year after the COVID-19 outbreak roiled global productivity. Economists surveyed by Bloomberg expect the nation’s GDP to grow 2.1% compared to a 4.4% estimated decline in the United States.

Some analysts also indicated that China’s growing exposure to the global bond indexes is acting as a driver of increased inflows into its once tightly controlled capital markets. Beijing has loosened its grip over its bond markets in the hope of increasing acceptance in world-wide debt benchmarks, per an article published on MarketWatch.

“Over the next decade, Morgan Stanley analysts expect the move to help China attract up to $3 trillion worth of portfolio inflows, and for the yuan to account for up to 10% of global reserve assets by 2030,” as quoted on the MarketWatch article.

ETF Impact

The strength in the yuan is a plus for the fund CYB. However, stronger currency is a negative for large-cap stocks that have greater foreign exposure. On the other hand, small-cap stocks that are tied to the domestic economy stand to gain from the stronger currency. The pattern appears to have held strong in this case as well.

KraneShares Bosera MSCI China A Share ETF (KBA - Free Report) has about 34% focus on mid-and small-cap stocks. The fund has gained a solid 16% past three months (as of Oct 1, 2020).

VanEck Vectors ChinaAMC SMEChiNext ETF (CNXT - Free Report) , which tracks the performance of the 100 largest and most-liquid China A-share stocks listed and trading on the Small and Medium Enterprise Board and the ChiNext Board of the Shenzhen Stock Exchange, has gained 15.1% in past three months (as of Oct 1, 2020).

On the other hand, large-cap China ETFs like iShares China Large-Cap ETF(FXI) have gained about 5.9% during the timeframe.

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