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Triggering partial rebounds in the Australian dollar, South Korea won, Thai baht, and Indonesian rupiah. However, the yuan’s rebound may be short-lived if Chinese health authorities can’t adequately contain the domestic or international spread of coronavirus, an epidemic that the World Health Organization is now calling COVID-19.
If you’re concerned by the yuan’s recent bout of extreme volatility, you — as a small business owner or independent investor — may want to develop a hedging strategy to reduce foreign exchange (FX) risk. In particular, FX forwards are popular amongst traders or business owners who are looking to minimize their exposure to currency risk by locking in a favorable exchange rate.
What’s Next for The Yuan Against Major Currencies?
The yuan’s most recent decline, which passed key resistance thresholds to eventually bottom out at 6.866 yuan against the U.S. dollar, was broadly underpinned by two key events:
The first cause was the sudden surge in COVID-19 deaths and diagnosed cases in mainland China. At the time, domestic health authority reports indicated that the rate of new COVID-19 cases had peaked. When conflicting news dropped on already jittery investors, the subsequent market pullback created significant downward trading pressure on the yuan.
The second cause was the unexpectedly low levels of factory activity recorded in key industrial provinces. Although a considerable number of manufacturing plants have come back online, chronic labor force shortages and COVID-19 quarantine and prevention procedures continue to disrupt the resumption of full-scale business and manufacturing output.
At this point in time, any further forecasts regarding the value of the yuan are contingent on unreliable assumptions about the current scale of the COVID-19 outbreak and the success of China’s ongoing control efforts. Moreover, the yuan’s price will also be impacted by a range of conventional value modifiers, including China’s upcoming Foreign Direct Investment report and the success of the phase one trade deal recently signed between Beijing and Washington.
How Could You Have Benefited from the Yuan’s Dip?
If you’ve been keeping a close eye on USD/CNY trading charts, you may have viewed the yuan’s recent dip as a low-cost opportunity to lock in FX forwards or increase your foreign currency holdings. If the worst of the COVID-19 epidemic is behind us, then currency holders will likely see a sharp narrowing in the USD/CNY trading range.
Despite the ongoing local correction, technical analysis of the USD/CNY indicates that the dominant bull trend remains intact for the long-term. To restart channel breakout momentum, the pair will need to advance through a measured move and establish long-term support above 7.024. At the time of writing, the USD/CNY has punched above the psychologically important 7.000 range and closed at 7.033 yuan to the dollar.
Unfortunately, the yuan’s rebound may be showing signs of slowdown. Yesterday, the USD/CNY even dipped below key resistance around 6.700. Fortunately for chartists, buyback momentum for the region’s key trading pair remained firm, with surging trading volume leading a near-term rally past key technical indicators in the 6.740-6.750 trading range.
If the yuan manages to maintain bullish sentiment, it will likely secure comparable trading pair gains against other major currencies, including the Euro, Pound Sterling, and Australian Dollar. Given the strong long-term prospects of China’s equity markets, foreign exchange speculators and independent currency traders largely signaled “strong buy” during the dip, leading to a surge in low-cost yuan holdings.
Remember, technical prospects for a strengthening yuan are heavily dependent on the credibility of Chinese reports pertaining to the COVID-19 outbreak. China’s state health authorities have already been accused of lying about the situation in Hubei Province and misreporting COVID-19 case numbers. As of the time of writing, 72,438 COVID-19 cases have been recorded in China, resulting in 1,869 deaths.
Two Ways Businesses Hedge Against the Yuan’s Volatility When Trading in China
When assessed through the lens of a portfolio manager or commercial business owner, the yuan’s higher than usual volatility poses significant challenges from a currency risk perspective. For businesses that operate/invest in China or frequently convert between major yuan trading pairs, there are two main ways to mitigate currency risk.
1. Utilize FX Instruments to Directly Hedge Currency Risk
Given the appropriate expertise, FX trading instruments give investors or business owners a tremendous amount of flexibility to quickly adjust FX holdings and account for future currency risk. If your objective is to maximize the exchange rate conversion for future cash flow from the Chinese market, you can use FX forwards or spot trading contracts to lock in advantageous exchange rates.
2. Build a Portfolio Around Hedged Assets
Investing in hedged assets, such as hedged mutual funds or hedged exchange-traded funds, is one of the simplest methods of minimizing international or domestic currency risk. Unfortunately, because of their relative simplicity, hedged assets can be a sub-optimal option for currency risk management. Higher expense ratios and a general lack of versatility are the main downsides to using hedged assets. For the most part, business owners tend to have the most difficulty developing a portfolio-based hedging strategy. This is because pre-hedged indices or sector-specific benchmarks are rarely able to simulate China’s trillion-dollar business operations or currency trading markets.
Key Takeaway: Prepare for Future Yuan Volatility
Despite the yuan’s recent rebound, coronavirus-induced volatility is expected to continue affecting Chinese markets for at least the next six months. Implementing an FX risk management strategy will not only limit your exposure to future downward movements in the yuan, it will also give you the means to quickly adjust your FX contracts or currency holdings to benefit from time-sensitive rebounds in key yuan trading pairs.
This article was originally posted on FX Empire