[PairTheBoard]

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i'm very comfortable betting that the 3.41% "premium" is WAAAAAAYYYYY small relative to what it will turn out to be in a year (i.e. the spot price has kept the futures price tied down via arbitrage). the yuan has appreciated 3.27% since just may 7 2007 and neither the chinese economy nor the inflation expectations there have been reduced at all...AND the olympics will certainly bring significant inflows of capital to china pushing up the currency.


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Thanks for getting those figures Barron. That gives us the full picture. That premium is smaller than I expected. However, I'm still not convinced about your interpretation. If enough money were put into purchases of futures based on your evaluation of the future EV for the USD/CNY then I don't think arbitrage could hold the futures price down. If market guesses about coming U.S. interest rate cuts can drive up the futures price despite arbitrage then so can market guesses about future values of USD/CNY. After all, isn't that what the market is trading? Money pouring into the futures would bid their price up. The market just doesn't share your view. But that's actually a good thing if you're right about future values of USD/CNY and you make the bet.

Edit:
Thinking some more about how expectations of U.S. interest rate cuts affect the dynamic. From the viewpoint of the arbitrage player, this reduces his expected cost due to the interest rate differential. Thus the premium due to that factor should actually be less than it would be based on current interest rates. Yet it's more? Why? If that really is the factor the reason would be because it causes the market to expect the dollar to weaken further thus causing future values of the USD/CNY to be greater, if China allows it. So even with this factor it is the market's view of future values for the USD/CNY exchange rate that is driving the premium.

If the market knew for a fact that China was going to unpeg the Yuan in say 11 months but keep it pegged right now you can bet your house that so much money would flow into Yuan futures that all the arbitrage in the world would not hold the price down. People would still certainly borrow dollars to buy Yuan right now. But they wouldn't waste their Yuan on little premiums selling USD/CNY futures contracts barely above current spot prices. They would just hold the Yuan for 11 months.





PairTheBoard