Worst yuan drop since 2016, options traders off guard

Traders rushed to protect against further losses in the yuan after the currency suddenly sank the most in more than three years.

A gauge measuring demand to buy bearish contracts on the offshore yuan surged the most since early 2018 yesterday. The move came after U.S. President Donald Trump threatened to levy new tariffs on the country’s goods. China’s foreign ministry said officials were still planning to travel to the U.S. for the next round of talks but was unable to confirm when amid signs that a delay is being considered.

The currency had been almost flat against the dollar since the end of February on speculation that the world’s two largest economies were edging closer to a trade deal. The yuan has become part of the negotiations after the U.S. raised concern that Beijing is deliberately depreciating its currency. Analysts expect any potential agreement will include a clause on currency stability.

“Investors will remain bearish on the yuan, as they reprice in trade-war risks because the new developments are a reversal of previous positive progress,” said Ken Cheung, a senior foreign-exchange strategist at Mizuho Bank Ltd. in Hong Kong. “The news was unexpected. Stop-loss orders will push the yuan even lower.”

The yuan may weaken gradually against a basket of currencies, as rapid depreciation versus the dollar “may not be palatable” to policy makers, Citigroup Inc. strategists Gaurav Garg and Lu Sun wrote in a note. A Bloomberg replica of the CFETS RMB Index, which measures the yuan versus 24 peers, stabilized after hitting the highest since June late last month.

The latest developments in the trade dispute have “thrown a monkey wrench” into the theme that yuan stability in recent months will anchor other currencies in Asia, said Jason Daw, head of emerging-market strategy at Societe Generale SA in Singapore. The offshore yuan could drop to 6.9 a dollar this quarter if the U.S. raises tariffs and the two countries stop active talks.

The offshore yuan’s three-month risk reversal jumped 39 basis points, the most since February 2018, to 0.63 percent. While this reflects higher demand for short-yuan wagers in the options market, the level is low compared to the aftermath of the country’s 2015 depreciation. That suggests traders are not yet in panic mode.

The offshore yuan tumbled as much as 1.3 percent, the most since January 2016, before paring losses to trade 0.68 percent lower at 6.7815 a dollar as of 5:04 p.m. in Hong Kong. The onshore currency – which hadn’t traded since April 30 due to a holiday – dropped 0.47 percent, the most in nearly three months, to 6.7667. Bloomberg