Bank of America's Mitts linked to Chinese renminbi are a bullish bet on China, global economy

By Emma Trincal

New York, Aug. 7 - Bank of America Corp.'s 0% Currency Market Index Target-Term Securities due August 2015 linked to the Chinese renminbi/dollar exchange rate measure are another way for investors to express a positive view on China and the rest of the world, sources said.

The underlying exchange rate represents a long position in the renminbi relative to the dollar, according to an FWP filing with the Securities and Exchange Commission.

The payout at maturity will be par of $10 plus 125% to 145% of any increase in the value of the exchange rate measure. If the value of the exchange rate measure decreases, the payout will be par. The exact participation rate will be set at pricing.

Bad timing

"The idea may not be bad. But there may be a better time for this bet," said Marc Chandler, global head of currency strategy at Brown Brothers Harriman.

"The bet of the notes is that the Chinese currency will appreciate against the dollar. It could be true. But at least in the first year, it's not going to happen."

Chandler said that China's slowdown has led its government to try to boost the economy. In part, the government has kept the renminbi from appreciating in order to stimulate exports. China has also launched a stimulus package involving rate cuts and increased government spending.

"Most recently, China has been experiencing currency outflows. The economy out there has been weakening," he said.

"How long will they keep the currency low? Six months to a year probably."

Chandler said that two factors will determine whether the Chinese renminbi appreciates or not.

"Short term, you are at a disadvantage with these notes because people are very concerned. If China slows down faster than they're admitting to, you'll continue to see an exodus of renminbi out of China. It's not going to help your trade," he said.

Inflation is the long-term factor.

"If China in three years experiences a lower inflation than the U.S., its currency in real terms will appreciate. So it may not be a bad idea. I just wouldn't do the trade right now," he said.

A 'decent bet'

Dan Dorrow, head of research at Faros Trading, LLC, said that "it's a moderately attractive bet," although "three years out is a long time to make that bet."

Over the short term, he said that the fears of the Chinese government letting the currency depreciate to stimulate the economy are overblown.

"They're still controlling the currency. Right now they're controlling direct credit domestic policies. They're not using FX. I don't think they're going to actively push down their currency. The most they can do is stop the renminbi from appreciating," he said.

A lot will also depend on the future of the flight to quality into dollars and Treasuries.

"It all boils down to what's your view on the world. If you think that three years from now, the euro zone crisis is over, the market is up, it would be good for the Chinese beta. It's purely following the market," Dorrow said.

"I think the dominant factor will be people getting out of the dollar, the world becoming a safer place, the end to the flight to quality. People will buy Asian, emerging market currencies. China will join that trend.

"If you can leverage that trend with this note, great. And if the world goes off the cliff, you still have the principal protection. It's a decent bet."

The notes are expected to price in August and settle in September.

Bank of America Merrill Lynch is the underwriter.

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