Volatility Knocking Out Yuan Carry Traders

The yuan has gone from being the most attractive carry trade bet in emerging markets to the worst in the space of two months as central bank efforts to weaken the currency cause volatility to surge.

The yuan’s Sharpe ratio, which measures returns adjusted for price swings, turned negative this year as three-month implied volatility in the currency rose in February by the most since May, when the Federal Reserve signaled plans to cut stimulus. The exchange rate tumbled the most since 2010 on Feb. 25 amid speculation the People’s Bank of China was intervening to deter one-way bets on currency gains.

“A lot of investors globally were invested in the yuan because of the interest-rate differential and the low volatility,” Rajeev De Mello, who manages $10 billion as Singapore-based head of Asian fixed income at Schroder Investment Management Ltd., said in a Feb. 25 phone interview. “All of a sudden the low volatility part of the argument is no longer there.”

Bloomberg

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