(Aug 5): The offshore yuan strengthened through China’s daily reference rate for the first time since November, as traders rushed to abandon a once popular short strategy.

The yuan jumped to as high as 7.1125 per dollar, trading at a premium to Beijing’s so-called fixing and close to erasing this year’s losses. That’s a sign market sentiment had turned more positive, after concerns over China’s growth had sent the currency to the lowest since November last month.

Monday’s rally came as risk appetite soured after weaker-than-expected US data fanned fears of a recession there. That prompted traders to walk away from a popular strategy which involves them borrowing the likes of yuan and yen cheaply and buying higher-yielding currencies such as the Mexican peso.

The rapid unwind of the strategy, known as the carry trade, led to a 1% surge in the yen and 2% slump in the Mexican currency on Monday. The drama in global markets intensified late last week, when poor US payrolls data prompted bets that the Federal Reserve may need to cut interest rates aggressively to avoid a hard landing.

“The increase in the unwinding of short-yuan positions is driving the jump,” said Ken Cheung, chief Asian FX strategist at Mizuho Bank. “If the aggressive Fed rate cut pricing is materialized, we are likely to see the broad emerging-market Asian currencies rally.”

Carry Trade Unwind Extends as Peso Sinks, Yen and Yuan Surge

The rebound in the yuan is welcoming news for Beijing as it gives the People’s Bank of China more room to ease monetary policy without worrying about the stability of the exchange rate. The authorities may slash rates for one more time in the first quarter next year, following a reduction in late July, according to economists surveyed by Bloomberg at the end of last month.

On Monday, the PBOC set the fixing at 7.1345 per dollar. The yuan pared earlier gains to trade about 0.4% stronger in both onshore and overseas markets around 7.14.

Now, with the yuan gaining so quickly, the PBOC may even use the fixing to limit any out-sized advance, according to Malayan Banking Bhd. The reference rate, which is Beijing’s favorite tool when it comes to guidance for the foreign-exchange market, limits the onshore currency’s moves by 2% on either side.

“With the external forces shifting drastically for the yuan at this point, the fix is now a counteracting force to slow the rate of appreciation of the currency,” said Fiona Lim, senior currency strategist at Malayan Banking Bhd.

Uploaded by Siow Chen Ming