World’s Biggest Jump in Volatility Revives Dim Sum: China Credit
Expectations for swings in the yuan climbed the most in the world in the past three months, sparking a rally in Dim Sum bonds as the central bank signaled a wider limit on daily exchange-rate moves.
Three-month implied volatility for the currency offshore, a measure used to price options, jumped to 2.1 percent, from 1.46 percent on Aug. 22, according to data compiled by Bloomberg. The onshore yuan and the Japanese yen had the next biggest increases among 53 currencies against the dollar. Investors buying renminbi bonds in Hong Kong drove the average yield down to an eight-month low of 4.84 percent on Nov. 15, a Bank of China Ltd. index shows.
China is pledging faster policy change as its economy shows signs of recovery and the U.S. prepares its twice-yearly report on exchange-rate manipulation by trading partners this month. Chinese central bankers have said they will widen the yuan trading band “at some point” and currency convertibility is the next step.
“The market is starting to price in chances of a widening of the band,” said Paula Chan, who helps manage $38 billion of Asian fixed-income assets at Manulife Asset Management in Hong Kong. “This is something that I expect to happen. The appreciation is coming back. The economic data is not that bad and is picking up quite nicely.”
A separate options market gauge showed traders are the least bearish since May. Contracts granting the right to sell the yuan cost 0.3 percentage point more than those allowing purchases, according to the six-month risk-reversal rate. That’s down from as high as 1.15 percentage points on Sept. 4. Options grant investors the right, but not the obligation, to buy or sell an asset.
The yuan gained 0.01 percent to 6.2283 as of 9:36 a.m. in Shanghai, bringing this week’s advance to 0.12 percent, after a manufacturing gauge showed output may have expanded for the first time in 13 months. A preliminary reading of production was 50.4 in November, compared with 49.5 in October, according to the purchasing managers’ index released by HSBC Holdings Plc and Markit Economics.
The currency, allowed to trade as much as 1 percent on either side of the daily fixing, has tested the upper limit most days this month. The band may be widened to 1.5 percent and appreciation is a “nice kicker” for investors sifting through the creditworthiness of Dim Sum issuers, Manulife’s Chan said.
The PBOC widened the yuan trading band to 1 percent from 0.5 percent against the dollar on April 16. The currency is allowed to fluctuate 3 percent on either side of the yuan’s daily fixing rate versus the euro and the yen. A wider band is possible in the first quarter, the Xinhua News Agency reported today, citing unidentified people in the finance industry.
“They will likely go to 1.5 percent and not go straight to 3 percent because they would lose control of the market,” said Irene Cheung, a currency strategist in Singapore at Australia & New Zealand Banking Group. “A wider band means a more flexible and hence stronger yuan because the perception is that China always tried to keep its currency undervalued.”
The yuan may appreciate to 6.16 per dollar by end-2013, according to the median forecast of 24 analysts surveyed by Bloomberg, stronger than the 6.22 estimate at the end of September. Twelve-month non-deliverable forward contracts for the yuan advanced 0.9 percent this year, pricing in a discount of 1.6 percent to the onshore spot rate.
The gains are driven by inflows fanned by monetary stimulus programs in developed economies and recent improvements in China’s economic data, according to Nikko Asset Management Co., the biggest asset manager based in the region with $166 billion.
“Liberalization of the renminbi is likely to remain gradual, with several small steps already being taken to allow more two-way flexibility,” John Vail, Tokyo-based chief global strategist, wrote in a note on Nov. 16, predicting 2 to 3 percent appreciation per year in the currency.
The prospect of full convertibility is in the “distant future” and unlikely to sway options traders as yet, according to Dirk Gradehand, senior currency-options trader in Singapore at DZ Bank AG, Germany’s largest cooperative lender.
“The Chinese want things to flow slowly, not an abrupt revaluation,” Gradehand said in an interview on Nov. 20. “A repeg or band widening is unlikely as the new leadership tries to build a good relationship with the U.S., so they will play along the rules of slight yuan appreciation.”
Credit-default swaps protecting the nation’s sovereign debt fell two basis points to 60.7 basis points yesterday, the lowest level since November 2010, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market. That compares with 147 basis points at the start of 2012.
Reviving bets on the yuan appreciation are driving Dim Sum bond yields lower, sending the average yield down six basis points this month, according to the Bank of China index. The yield had its biggest monthly increase in six months in May when the yuan dropped 0.9 percent.
Caterpillar Inc. and Volvo AB sold Dim Sum bonds in Hong Kong this month, each raising 1 billion yuan, following a 500 million yuan offering by Renault SA, according to Bloomberg data.
The yield on onshore 10-year government bonds fell four basis points, or 0.04 percentage point, this month to 3.54 percent, according to Chinabond data. The rate compares with the similar-maturity U.S. Treasury at 1.68 percent.
The average Dim Sum sovereign yield has dropped 11 basis points since September to 2.95 percent yesterday, shrinking the gap with the U.S. 10-year Treasury yield to 128 basis points from 143 basis points, according to data from the Bank of China.
The Treasury Department delayed its latest currency assessment in October after declining to name China a manipulator in a May 25 report. Some U.S. lawmakers say a managed yuan gives Chinese exporters an unfair edge in global trade.
“The new leadership is apparently trying to avoid China being named as a currency manipulator and seems to promote liberalization quite aggressively,” said Tadashi Tsukaguchi, chief fund manager of the global macro hedge fund in Tokyo at Mizuho Securities Co. “For dollar-based investors, the yuan is attractive now with a positive currency outlook and interest- rate differentials.”
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