Yuan Band Bets Boost Dim Sum for Fullerton to UBS

Signs China will widen the yuan’s trading band have driven a rally in Dim Sum corporate bonds, cutting their yield premium in May by the most in eight months.

The average yield on investment-grade corporate bonds declined seven basis points this month to 3.176 percent on May 29, the least since November 2011, according to an index compiled by HSBC Holdings Plc. The gap over offshore government debt fell 12 basis points in May, the most since September, to 86. Yields on investment-grade debt climbed 27 basis points in emerging markets and increased 25 basis points in Asia, Bank of America Merrill Lynch indexes show.

UBS Global Asset Management and Fullerton Fund Management, whose yen-denominated Dim Sum funds are 2013’s best performers, are both favoring corporate yuan bonds because of their higher yields and more-frequent issuances. People’s Bank of China Deputy Governor Yi Gang said last month the authorities will widen the limit on daily yuan moves “in the near future,” while Premier Li Keqiang said this month the government will propose plans this year for capital-account convertibility.

“China has highlighted foreign-exchange liberalization as one of the priority reforms, which will likely entail band widening in the near future,” said Patrick Yeo, portfolio manager for the Fullerton RMB Fixed Income Fund in Singapore. “This would be positive for offshore yuan sentiment.”

Yeo prefers investment-grade debt, including banks and insurers that tend to be more “defensive” in a slowing economy, he said in a May 29 e-mail interview. He also favors shorter-dated paper on concern that global interest rates will rise. His fund returned 17.5 percent this year to its Japanese-currency investors, reflecting the yen’s declines.

Capital Inflows

The average yield on offshore yuan sovereign bonds rose six basis points this month to a one-month high at 2.32 percent yesterday, the HSBC index showed. That’s the first monthly increase since September. The yield on China’s benchmark 10-year government bond was steady at 3.44 percent in May.

Fullerton, which manages the equivalent of $9.5 billion, is also looking to invest in onshore government bonds through the Qualified Foreign Institutional Investor program because the yields are more attractive, Yeo said.

The yuan has strengthened 1.5 percent this year, compared with last year’s 1 percent gain, driven by inflows of capital. The currency, which touched a 19-year high on May 27, fell 0.1 percent today to 6.1363. In the offshore market, the spot rate climbed 0.9 percent since the end of March and was at 6.1469 today in Hong Kong, according to data compiled by Bloomberg.

Trading Band

The People’s Bank of China sets a daily reference rate for the yuan against the dollar in Shanghai, and limits the spot rate’s trade to a maximum 1 percent on either side. The currency has stayed within 0.1 percent of the upper limit on most days since October. The central bank, which last widened the band in April 2012 from 0.5 percent, has raised the reference rate by 1.7 percent so far this year, compared with 0.24 percent for the whole of 2012.

Yuan gains may slow on concerns about China’s slowing economy, and if the Federal Reserve scales back debt purchases that fueled demand for emerging-market assets, said Banny Lam, Hong Kong-based co-head of research at Agricultural Bank of China International Securities Ltd, a unit of the nation’s third-largest lender.

“China’s growth is slowing more than expected,” he said. “This may weigh on the yuan’s exchange rate.”

Slowing Economy

The International Monetary Fund on May 29 cut its China growth forecast for this year to 7.75 percent from 8 percent, saying that the government needs to make “decisive” policy changes to ensure sustainable growth. China’s manufacturing is set to shrink in May for the first time in seven months, according to a report by HSBC Holdings Plc and Markit Economics.

The cost of insuring China’s debt against non-payment rose three basis points this week to a seven-month high of 82 in New York yesterday, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market. The credit-default swap for Japan is at 77, while that for the U.S. is 28.

Playing Catch-Up

The yuan is playing catch-up after gaining almost nothing last year and will rise another 1 percent to 2 percent before the end of the year, Ashley Perrott, Singapore-based head of pan-Asia fixed-income at UBS Global, said in a May 29 phone interview. UBS Global, whose yen Dim Sum fund returned 23 percent this year, oversees the equivalent of $624 billion.

The Chinese currency will gain to 6.1 per dollar by the end of 2013, according to the median estimate in a Bloomberg News survey of 33 analysts, while HSBC Holdings Plc forecast in March that the yuan will be fully convertible within five years.

China will push ahead with opening its capital account because current economic conditions are favorable, the PBOC’s Yi said on April 18 in Washington, where finance chiefs from the Group of 20 nations met for talks on issues including exchange rates. Yi said a day earlier that a widening of the yuan’s trading band was likely “in the near future.”

Chinese government agencies including the central bank will discuss a yuan capital-account convertibility plan in June, the Economic Information Daily reported on May 28, without saying where it got the information from.

Cleaning Up

The State Administration of Foreign Exchange said on May 5 that it would send notices to companies whose goods and capital flows don’t match, as well as to those importing large sums of cash. The regulator also told lenders to limit foreign-currency loans to 75 percent of deposits by the end of June. This is a precursor to band-widening, Bank of America Corp. said in a report, and the steps are aimed at ensuring yuan trades are for genuine needs rather than for speculation.

Yuan positions at Chinese financial institutions stemming from foreign-exchange transactions, a gauge of cross-border capital flows, rose by 1.22 trillion yuan ($199 billion) in the first three months of the year, more than four times that of a year earlier, central bank data show. April’s 294 billion yuan increase compares with a 61 billion yuan decline a year earlier.

“The band is unlikely to widen until flows are less one way and there is more of a balance between the spot and fixing,” said UBS Global’s Perrott. “It seems unlikely within the next few months.”

Currency policy changes are accelerating before President Xi Jinping is due to meet U.S. President Barack Obama in California early next month in their first face-to-face talks since China’s power transition in March. New Zealand and China are in talks to make their currencies directly convertible, while Industrial and Commercial Bank of China Co.’s Singapore branch started yuan clearing services this week.

“We expect offshore yuan bond yields to remain fairly well-anchored and well-supported, given that it is the easiest access for investors to get renminbi exposure,” said Perrott, referring to the yuan by its official name. “We’ll generally stay with corporate unless we were to expect a very sharp contraction in China’s economy, which is not what we expect.”

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