Record Yuan Shows Resilience to Fed as Lew Visits: China Credit
China fixed the yuan at a record high amid U.S. calls for faster appreciation and investors are tipping renminbi bonds to be one of the best bets in emerging markets as the Federal Reserve prepares to rein in stimulus.
The central bank raised the yuan’s reference rate to 6.1315 per dollar yesterday and the currency has gained 2.3 percent this year, the best showing among 24 developing-nation currencies tracked by Bloomberg. The yield on China’s 10-year sovereign bonds climbed one basis point in May when Federal Reserve Chairman Ben S. Bernanke first raised the possibility of curbing debt purchases. Indonesia’s yield surged 48 basis points as the exit of foreign investors strained its finances.
U.S. Treasury Secretary Jacob J. Lew, who will meet officials in Beijing today, has called for China to speed up its move to a market-determined exchange rate after the nation’s currency reserves jumped to a record $3.66 trillion at the end of September. Western Asset Management Co. is buying Dim Sum corporate bonds to gain from the yuan’s appreciation while Amundi Hong Kong Ltd. says it is positive on the currency.
“We don’t expect the renminbi to experience any particular pressure once the Fed begins to taper,” said Mitul Kotecha, global head of foreign-exchange strategy in Hong Kong at Credit Agricole CIB, the fourth-best forecaster of the currency according to Bloomberg Rankings. “China has a strong external position and is therefore not vulnerable to capital outflows.”
The yuan, which touched a 20-year high on Oct. 25, is forecast to gain 1.3 percent to 6.01 per dollar by the end of 2014, according to the median estimate in a Bloomberg survey. Its three-month implied volatility is 1.9 percent, the lowest in Asia after the greenback-pegged Hong Kong dollar. That compares with 14.3 percent for the Indonesian rupiah and 9.3 percent for the Australian dollar.
The yield on China’s 10-year government debt climbed to a five-year high of 4.47 percent on Nov. 13, after the nation’s leaders said following a four-day Communist Party plenum that market forces would be given a “decisive’” role in allocating resources.
This suggests the market will have more freedom to determine interest and exchange rates and, if central bank interventions decline, the yuan should strengthen, Dariusz Kowalczyk, a Hong Kong-based strategist at Credit Agricole CIB, said in a Nov 13 interview. U.S. Treasuries (USGG10YR) due in a decade yielded 2.7 percent yesterday while the rate in Australia was 4.2 percent.
“In a world of fairly low interest rates, China’s bond yields are quite attractive, and there is less currency risk than somewhere like Australia where volatility is a lot higher,” said Desmond Soon, a Singapore-based portfolio manager at Western Asset.
Soon, who predicts the Chinese currency will gain around 2 percent annually, said he’s buying yuan debt, including Dim Sum bonds issued by Ford Motor Co. and Fonterra Cooperative Group Ltd. because of low credit risk.
China’s economy expanded 7.8 percent in the three months through September, reversing a two-quarter slowdown that put the government at risk of missing its 7.5 percent growth target for 2013. Reports this month showed industrial output, exports and manufacturing rose more than economists projected in October, while inflation quickened to 3.2 percent from 3.1 percent in September.
“The yuan is going to see gradual appreciation,” said Ayaz Ebrahim, chief investment officer for Asia ex-Japan at Amundi, which manages $1 trillion globally. “We are positive on the currency because of still-competitive exports, a strong current account surplus and positive announcement in the third plenary session.”
China’s yuan faces increasing appreciation pressure as the nation’s trade surplus widens, Liu Li-gang and Hao Zhou, economists at Australia and New Zealand Banking Group Ltd., wrote in a Nov. 8 research note. That’s in contrast with Indonesia, which has a trade deficit of $657 million.
The yuan may “remain broadly steady,” Stephen Chang, head of Asian fixed-income at JPMorgan Asset Management in Hong Kong, said in a Nov. 12 interview. “Current-account deficit countries remain vulnerable when capital flows have paused or reversed.”
The yuan is significantly undervalued, the U.S. Treasury said in its twice-yearly review of currencies and economic policies, although it stopped short of naming China or any other major trading partner as a currency manipulator.
Secretary Lew will discuss the importance of countries allowing financial markets to determine their exchange rates, Treasury officials who requested anonymity as a condition for briefing reporters said on Nov. 8.
The People’s Bank of China limits the yuan’s movements to 1 percent on either side of a reference rate set every day. It widened the range from 0.5 percent last year, and has pledged to keep the exchange rate “basically stable” while seeking to increase the currency’s two-way flexibility.
The nation’s rising foreign reserves point to structural appreciation in its currency, and net capital inflows may strengthen further if the economy continues to stabilize, according to a Nov. 1 research note from Singapore’s Oversea-Chinese Banking Corp. Yuan positions at financial institutions accumulated from sales of foreign exchange, a gauge of inflows, climbed 126.4 billion yuan in September to 27.5 trillion yuan, according to PBOC data.
“The Chinese debt market is going to be more dependent on the outlook for the policy decisions of the PBOC rather than those of the Fed,” said Christian Wildmann, a fixed-income portfolio manager in Frankfurt at the subsidiary of Germany’s Union Investment Group, which oversees about 201 billion euros ($270 billion) in assets. The Chinese currency is also “more resilient than the Brazilian real, Turkish lira, South African rand, Indonesian rupiah and Indian rupee.”