Flash: Greater FX volatility would help deter CNY carry - BTMU

FXstreet.com (Barcelona) - Cliff Tan, East Asian Head of Global Market Research at the Bank of Tokyo Mitsubishi UFJ believes that the next few weeks will offer more insight into whether and how Chinese authorities might better manage their capital inflows problem this year.

However, one obvious point he highlights immediately is that the often extremely high Sharpe ratios of this strategy is a direct consequence of the unwillingness of Chinese authorities to allow greater actual volatility within their modest +/- 1% trading band. He comments, “Our favorite analogy had been of a child playing in a bigger backyard but where the child is tethered via a short cord to a pole. The pole may be moved around a bigger backyard, but it doesn’t mean the child is really free to play.”

Further, he comments that greater exchange rate volatility can act as a deterrent against extreme carry trade positions, but only if authorities allow such variability to take place day-to-day. Greater variability is also consistent with official desires to strengthen the exchange rate trading mechanism in preparation for a day when China will have an essentially open capital account. He finishes by writing, “But to the extent authorities hold themselves back, they have only themselves partly to blame for the attractiveness of the carry trade.”