Investors place bets to profit from China forex shift

With speculation mounting that China will soon revalue its currency, investors are scrambling to place bets on what could be the biggest event to rock the foreign exchanges in years. Some of these bets involve outright buying of Asian currencies such as the yen or Singapore dollar, or use of derivatives including non-deliverable forwards and options to create portfolios that could offer handsome returns if Beijing revalues the yuan, also known as the renminbi.
"It will be a big event for the foreign exchange market," said Marvin Barth, global currency economist at Citigroup. "It takes us into a brave new world in terms of what economic drivers and the constellation of different asset prices will look like."
The yen hit a 2-1/2-month peak against the euro and a one-month high against the dollar this week as speculators have snapped up the Japanese currency since US officials stepped up calls last week for China to act on its currency.
The United States has long pressed Beijing to allow a stronger yuan as Washington believes the current rate is keeping Chinese exports unfairly cheap.
Speculation reached fever pitch on Monday after comments from Chinese officials over the weekend that Beijing would prudently accelerate reform of its exchange rate system, although no timetable was given.
China's central bank governor Zhou Xiaochuan said there were no serious political or technical obstacles to reform of its currency, which is pegged to the dollar in a wafer-thin band around 8.28 yuan.
The yen and other Asian currencies are expected to gain if China revalues as they will no longer have to keep their currencies cheap to maintain export competitiveness in the face of a deluge of cheap Chinese goods.
The South Korean won hit its highest closing level against the dollar since November 1997 on Monday while the Taiwan dollar cleared a one-month high this week.
SINGAPORE DOLLAR: Sebastian Barbe, foreign exchange strategist at Calyon in Paris, singled out the Singapore dollar from its Asian counterparts.
"We are long on the Singapore dollar both against the dollar and the euro," said Barbe. "The idea being that the Sing dollar is linked to a basket and it's a safe haven in terms of credit quality."
The Singapore dollar is kept in a band against a trade-weighted basket of currencies. The basket of currencies is kept secret but is likely to include the currencies of many of the city-state's Asian trading partners.
"If the Korean won and Taiwan dollar appreciate, you will read that in Singapore's basket. The Malaysian ringgit, we estimate, is close to 20 percent of Singapore's basket and Malaysia may also revalue," said Barbe.
Likewise, Bear Stearns recommends buying the Singapore dollar against the dollar at S$1.6465, with a target of S$1.6420 followed by S$1.6310 and stopping losses if the rate hits S$1.6620.
DERIVATIVES: Investors are also piling into non-deliverable forwards, derivatives used by foreign exchange investors to bet on a change in the value of the yuan.
"NDF liquidity is stronger compared to the previous speculative episode in December 2004 and suggests that market participants are more convinced of a policy about-turn this time around," Singapore-based United Overseas Bank said in a note to clients.
The premium on one-year yuan NDFs hit 4,900 points on Monday, factoring in a 6.3 percent gain on the yuan in 12 months' time, the highest level since early 2004, according to Reuters data.
Calyon recommends its clients target 5,200 points before taking profits or dig in for the long haul.
"There are two possible trades: One is short-term, you just want to benefit from market pressure and the other is long-term. The NDFs could go as far as 10,000 points on the day China really announces they are moving," said Barbe.
But others say the NDF premium looks overstretched and at 6.3 percent is already pricing in a bigger move that many in the market expect this year.
Citigroup, in line with other investment banks, expects China to widen the yuan's trading band by a relatively small three percent this year.
Jeremy Gelber at Royal Bank of Scotland says investors could also benefit from buying one-year yuan call options, which bet on asset appreciation, and shorting NDFs as the call options are currently trading at cheap levels.
"There is some value in buying sensible-delta CNY calls since they are eminently fundable at current levels," he said.
Delta measures how movements in underlying asset prices affect the price of an option based on the asset.