China Currency Plunges Most In Over 5 Years, Biggest Weekly Loss Ever: Yuan Carry Traders Crushed

Tyler Durden's picture

And just like that the Chinese yuan devaluation has shifted away from the merely "orderly."

In the past few hours of trading, China, which as we reported two days ago has started intervening aggressively in the Yuan market (for the reasons why, read this), has seen its currency crash by nearly 0.9%, which may not seem like much, but is in fact the largest drop since December of 2008, and at last check was trading at around 6.18, even as the PBOC fixed the CNY reference rate 0.02% higher from the last official close to 6.1214, erasing pivot support point at 6.1346 and 6.1408.  Naturally this means that the obverse, the CNYUSD, has crashed to as low as 0.1620. Should this move sustain without reverting, this will be the biggest weekly loss ever!


The dramatic monthly plunge from the CNY perspetive is shown on the chart below.


There isn't much commentary on this most recent dramatic move aside from this commenbt by Zhou Hao, a Shanghai-based economist at ANZ, who said "CNY movements indicate that the authorities are determined to deter capital inflows and there were likely stop-losses triggered when the CNY broke key psychological levels."

What is more notable is that the move, while certainly intending to shake out the carry traders bent on riding the USDCNY ever lower, is starting to appear borderline erratic. As a reminder, and as we posted yesterday before the FT picked up the story earlier today, there is a lot of pain in store for those betting on a stronger Yuan, because while the move may not seem dramatic (by USDTRY standards), the reality is that the carry trade positions have massive leverage associated with them, with the pain level on $500 billion in existing carry trades beginning to manifest once the Yuan enters the 6.15-6.20 gap and becomes acute once the European Knock-In zone of 6.20 is crossed (see first chart below) and rising exponentially from there. In fact as we explained, should the renminbi break past 6.20 per dollar, which it is very close to right now, banks would be forced to call in collateral, accelerating the Yuan plunge, at which point the drop would become self-sustaining. The pain from that point on is around US$4.8 billion in total losses for every 0.1 above the average EKI (see third chart).

This is what we warned yesterday:

The total size of the carry trade is hard to estimate although even just looking at some of the onshore CNY positions accumulated, DB Asia FX strategist Perry Kojodjojo estimates that corporate USD/CNY short positions are around $500bn. The size of the carry trade and the fact that China saw significant capital outflows during the last period of substantial Renminbi depreciation in the summer of 2012 has led to concerns over what this might mean for both the Chinese economy and financial markets as well as broader global financial implications.

Morgan Stanley believes that one such carry-trade structured product that will be the "pressure point" for this - should the Yuan continue to depreciate - is the Target Redemption Forward (TRF) which has a payoff that looks as follows...

While this is just an example of a product payoff matrix to the holder, the broader point is that the USD/CNH market has a particular level (or range of potential levels) at which three factors can create non-linear price action. These are:

1. Losses on TRF products will (on average) crystallize if USD/CNH goes above a certain level. This has implications for holders of TRF products, who are mostly corporates;

2. The hedging needs of writers of TRF products (banks) mean that there is a point of maximum vega for banks in USD/CNH. Below this level banks need to sell USD/CNH vol; above this level banks need to buy USD/CNH vol;

3. The delta-hedging needs of banks are complex. As we approach the average strike (the 6.15 in the theoretical point of Exhibit 1), banks need to buy spot USD/CNH. Above this point but below the European Knock-in (EKI) (i.e., between 6.15 and 6.20 in Exhibit 1), banks need to sell spot. Then above the EKI, banks don’t need to do anything in spot.

From internal Morgan Stanley data, we estimate that the point of maximum vega is somewhere in the range of 6.15-6.20, and that the 6.15-6.20 in Exhibit 1 is reasonably indicative of the average strikes and EKIs in the market.

In other words, so long as the TRF products remain in place (i.e., are not closed out) and we remain below the maximum vega point (somewhere between 6.15 and 6.20), there is natural selling pressure by banks in USD/CNH vol. When we get above that level, there is natural vol buying pressure.



Of course, in the scenario that USD/CNH keeps trading higher and goes above the average EKI level, the removal of spot selling flow by banks and the need to buy vol means the topside move may accelerate.

Simply put, if the CNY keeps going (whether by PBOC hand or a break of the virtuous cycle above), then things get ugly fast...

How Much Is at Stake?
In their previous note, MS estimated that US$350 billion of TRF have been sold since the beginning of 2013. When we dig deeper, we think it is reasonable to assume that most of what was sold in 2013 has been knocked out (at the lower knock-outs), given the price action seen in 2013.

Given that, and given what business we’ve done in 2014 calendar year to date, we think a reasonable estimate is that US$150 billion of product remains.

Taking that as a base case, we can then estimate the size of potential losses to holders of these products if USD/CNH keeps trading higher.

In round numbers, we estimate that for every 0.1 move in USD/CNH above the average EKI (which we have assumed here is 6.20), corporates will lose US$200 million a month. The real pain comes if USD/CNH stays above this level, as these losses will accrue every month until the contract expires. Given contracts are 24 months in tenor, this implies around US$4.8 billion in total losses for every 0.1 above the average EKI.

Deutsche Bank concludes...

Looking forward it’s possible that the PBOC is not attempting to actively engineer a sustained depreciation of the Renminbi but rather is attempting to increase the level of two-way volatility in the market to discourage the carry trade and also excessive capital inflows. In terms of the broad risk going forward the sheer scale of the challenge the PBOC has set out to tackle likely means they will have to move with restraint. This is certainly a story to watch...

As Morgan Stanley warns however, this has much broader implications for China...

The potential for US$4.8 billion in losses for every 0.1 above the average EKI could have significant implications for corporate China in its own right, as could the need to post collateral on positions even if the EKI level is not breached.


However, the real concern for corporate China is linked to broader credit issues. On that, it’s worth reiterating that the corporate sector in China is the most leveraged in the world. Further loss due to structured products would add further stress to corporates and potentially some of those might get funding from the shadow banking sector. Investment loss would weaken their balance sheets further and increase repayment risk of their debt.


In this regard, it would potentially cause investors to become more concerned about trust products if any of these corporates get involved in borrowing through trust products. In this regard, this would raise concerns among investors, given that there is already significant risk of credit defaults to happen in 2014.

Remember, as we noted previously, these potential losses are pure levered derivative losses... not some "well we are losing so let's greatly rotate this bet to US equities" which means it has a real tightening impact on both collateral and liquidity around the world... yet again, as we noted previously, it appears the PBOC is trying to break the world's most profitable and easy carry trade - which has created a massive real estate bubble in their nation (and that will have consequences).


The bottom line is the question of whether the PBOC's engineering this CNY weakness is merely a strategy to increase volatility and thus deter carry-trade malevolence (in line with reform policies to tamp down bubbles) OR is it a more aggressive entry into the currency wars as China focuses on its trade (exports) and keeping the dream alive? (Or, one more thing, the former morphs into the latter as a vicious unwind ensues OR the market tests the PBOC's willingness to break their momentum spirit).

It appears, as Bloomberg notes, the PBOC is winning: "Yuan has gone from being most attractive carry trade bet in EM to worst in 2 mos as central bank efforts to weaken currency cause volatility to surge. Yuan’s Sharpe ratio turned negative this yr as 3-mo. implied volatility in currency rose in Feb. by most since May, when Fed signaled plans to cut stimulus."

So far the PBOC's "shock and awe" has impressed currency traders. Hopefully, the PBOC knows what it is doing because if indeed it causes the carry trade to unwind, the unwind could send the currency plunging well beyond the central bank's intended limits. What happens then nobody knows.

Curious for more? Read our first post in this series: Welcome To The Currency Wars, China (Yuan Devalues Most In 20 Years)

Finally, if indeed this is the start of the real carry unwind, things go from bad to worse: read "The Pig In The Python Is About To Be Expelled": A Walk Thru Of China's Hard Landing, And The Upcoming Global Harder Reset

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LetThemEatRand's picture

Juan carry trades.  Is that code for a drug mule?

"Carlos.  How is my Juan carry trades doin'?"

"He's collapsed again."

"Fuck.  Can we get some fuckin' water an' guns over there?"

"No fuckin' way.  Holder is sick"

dryam's picture

I really liked the bonus chart from the last article on this subject.

strannick's picture

Is China's currency still ''crushed'', when they are trying to devalue it??

Rock On Roger's picture

No different than a gold chart.

Same kinda waterfall.


Stack On

philipat's picture

And why not? Everyone else is playing the same game. Their 15 Tonnes of Gold purchased at giveaway prices from the Western Central Banks gives them a huge buffer. This is purely tactical. The longer-term strategy remains the same: a Yuan reserve currency backed explicitly or implicitly by Gold.

natty light's picture

Wonder if Jim Rogers is buying CYN on this.

GetZeeGold's picture




Last I heard....Jim was furiously buying gold.

SoilMyselfRotten's picture

So wills this mean stronger dollar, hence, gold pounding this morning?

wallstreetaposteriori's picture

I didn't know that you could carry trade the Yuan in the first place? 

UselessEater's picture

Yaun backed by gold as a world reserve currency or an SDR reset backed by gold with new Yuan clout, or?

I've read arguments for/against various cases..... just trying to fathom this is like being back in grade school

fortunately I have a bunch of ZH'rs commenting, ranting and espousing their world views. all educating and some mis-educating me  ...... so what's this yuan sh*t today leading to???

Wobbly banks making losses (bail-ins not finalised), currency war (China not ready / willing to take helm), more global jousting for the NWO or whatever its called (but it seems IMF & cohorts aren't quite getting their way 100%).... so more games likely to be played and more time needed for a 'popular' currency shift even though some seem to have hot money on March being the great reset month..... and March starts tomorrow!



max2205's picture

Another CB controlled crash.....Good Morning Vietnam! 

it aint easy's picture

It all leads to war in the end, no matter how the details play out..

TruthInSunshine's picture

Shorting the CNY is the easiest money one will ever be able to make.

No matter what is said, threatened or warned, by whomever and how frequently, the Chinese will continue to steadily devalue their currency, and U.S. Multinational Corporations will order their puppets in the congress & the White House to DO ABSOLUTELY NOTHING IN RESPONSE TO THIS other than talk.

There is trillions of factories & plants, along with R&D centers, built out by western firms on Chinese soil, essentially captive hostages of the Chinese Government, should trade wars break out, that benefit from being able to tap a cheaper CNY in their ongoing efforts to sell their products in both China & export markets, and this fits nicely with the 50 year business models they've

It is only a matter of a very short time frame before developed market equity indexes plunge now, and emerging equity markets outperform (if only in nominal terms due to said currency devaluation).

This is the appropriate time to reflect upon the fact that most wars are driven primarily by economic factors, so the alternative to this scenario would possibly (probably?) be some form of major regional hot war, since China truly is between a rock & a hard place at present.

Rock On Roger's picture

What if those trillions of factories & plants were to roll out zillions of drones and missiles?

I'd be careful of chanting USA too loudly.

USA helped win WWII because of her manufacturing capability.

History rhymes.

As in the past, so in the future.


Stack On

TruthInSunshine's picture

I'm doing no chanting of USA.

I'm pointing out that multinationals that have built trillions in factories/plants and R&D in China have NO national allegiance, and will lobby aggressively to ensure that there is no threat to utilizing those resources of production accordance with their long term business models.

UselessEater's picture

lobbying implies a degree of governmental independance needed to be won over.... not sure we have more than an appearance of this in any nation, so we back to your argument its about business models of TPTB with a little PR sprinkled on us all

TruthInSunshine's picture

Total agreement.

I should have said the Corporate Bosses will restrain their puppets.

philipat's picture


Yes, that is what the fundamentals suggest. This is truly "The American Crisis". However, when, shortly, TSHTF, you should expect the usual reaction, which is a flight to "Quality". That means a massive flight into USD and Treasuries, even though that is actually the source of the problem. So be careful with EM and PM investments short-term. Longer-term, yes, of coursee, you are correct.

hobopants's picture

So what happens when the last hope of globalization goes all in on a race to the bottom?

kita27's picture

.9%?!   Well run for the hills Ma Barker, before i call the feds!

prains's picture

...and you are who exactly valkir??

GetZeeGold's picture



I think it's safe to assume everyone is KGB at this point.

matrix2012's picture

Anonymous Ukraine releases Klitschko e-mails showing treason

here is the link to the released e-mails


Count of Lastovo's picture

Well, all those smart Chinese who bought gold are laughing now.       

Rock On Roger's picture

I think the problem is fonestar dumped his bitcoin and bought yaun.


Stack On

Judge Crater's picture

The end of the forex world is near.  Time to escape to my panic room.  Wait, I don't have a panic room.

ebworthen's picture

Well, this makes Chinese exports cheaper, eh?

Steps in establishing a reserve currency: 

  1. Have the best productive base.
  2. Debase your currency to kill the competition.
  3. Establish reserve currency bargaining power.
  4. Start 50 year process to maximize first 3 steps.
mrgneiss's picture

Don't forget stealth massive accumulation of the element with atomic number 79

Josh Randall's picture

It's going to be a bloodbath until they peg their yuan to gold and dump their remaining ust's on the same day

theliberalliberal's picture

Naturally this means that the obverse, the CNYUSD, has crashed to as low as 0.1620

The word you want is reciprocal.  

22winmag's picture

Something smells here, but then again, the "leader of the free world" has cock breath.

drstrangelove73's picture

Does he dig boning old white guys or being boned?I get it mixed up

Yen Cross's picture

  China wants to widen the current usd/cny trading band from .7% to 1% this summer, so that their bond market is more attractive. Good luck with that one!

LetThemEatRand's picture

When bankers fuck the Chinese, do the Chinese cup the balls of their overlords like the Americans and British?  Anyone know the Chinese symbol for "yes?"

saulysw's picture

The currency manipulators have been identified ...


Sum Ting Wong

We Tu Lo

Bang Ding Ow

Ho Lee Fuk


(Never gets old IMHO...!)

Kokulakai's picture

Will the PBOC sell dollars to buy yuan?

economisery's picture

The global economy desperately needs a circuit-breaker to bring a halt to the out-of-control asset bubbles that are being inflated everywhere.

The fact that it's the PBOC making the first sensible and responsible moves to this end, rather than the reckless baffoons at the FED, doesn't even suprise me anymore.

LetThemEatRand's picture

The Chinese invented the printing press in more ways than one.  Yellen blushes when she sees their toilet paper rolls.  P.S.  chicks blush when they orgasm.   And I just puked thinking about that in the Yellen context.  Then I shaved my head and bought a wig and I'm cool now.  

Pareto's picture

+1 man.....he he heeee.....just because.......

laomei's picture

Oh no, it went from a whopping 6.05 to 6.15, which is obviously a disaster.  When it dropped from 6.15 to 6.05 in no time at all no one says a damn thing.  Maybe, just maybe some people in charge know exactly what they are doing.  Oh no, the currency plunges and all the factories become highly profitable again instead of very slim margins.  Foreign goods become higher in price, while domestic goods remain more stable, increasing internal consumption.  Failing to see the problem here unless you're a dumbass muppet or john kerry who'll be making another trip to beg china to buy more airplanes.

Bonapartist's picture

wages dropping/stagnating in an inflationary enviroment means nobody can afford shit other than food/gas- gee that sounds familiar. and round and round the wheel goes- jobs shift from US to Mexico then to China then to Vietnam then to ????. these factories can be moved halfway around the world to chase cheaper labor in a matter of days.

laomei's picture

Wages have been going up very nicely here in China for a long long time.  Stagnant wages... I believe you're referring to the US since the 70s.