Yuan Forwards Discount Widening Shows Dim Sum Risk: China Credit

Yuan forwards are trading at the biggest discount to the spot rate in four years and the top Dim Sum debt underwriters predict a halt to appreciation.

Contracts that fix the currency in 12 months were 2.42 percent weaker than the current rate in Shanghai today, the most since February 2009, according to data compiled by Bloomberg. The currency has advanced 1.6 percent against the dollar since the end of 2012. The average yield on offshore yuan-denominated debt climbed to a five-month high of 3.8 percent on June 10, an HSBC Holdings Plc index showed.

China’s latest trade and manufacturing data trailed estimates, fueling concerns the central bank will halt currency gains to revive exports and economic growth, according to Standard Chartered Plc. HSBC said the dollar’s strength on speculation the Federal Reserve will scale back its stimulus could drive Dim Sum yields higher.

“The recent economic data have reinforced concerns that the yuan won’t appreciate further in the near term,” Crystal Zhao, a fixed-income analyst in Hong Kong at HSBC, the largest arranger of Dim Sum securities, said in a June 11 phone interview. “When the yuan softens, it’s inevitable that Dim Sum yields will rise. Higher U.S. Treasury yields and the dollar’s strength are also weighing on yuan assets.”

Forwards Decline

The yield on three-year U.S. Treasuries has climbed 22 basis points this quarter to 0.56 percent, according to date compiled by Bloomberg, while the rate on similar sovereign bonds in China was steady at 3.11 percent, show Chinabond data. The average yield on Dim Sum bonds rose 29 basis points, an HSBC index shows. China’s financial markets resumed trading today after a three-day holiday for the Dragon Boat Festival.

In Hong Kong, twelve-month non-deliverable yuan forwards, which reflect both interest-rate differentials and exchange-rate expectations, declined 0.4 percent in June. The contracts are settled in dollars and allow investors to buy or sell the currency at a set price on a specified date. They fell 0.3 percent today to 6.2840 per dollar, according to Bloomberg data. The offshore yuan was trading at a 0.1 percent discount to the spot rate in Shanghai.

The yuan closed at 6.1344 per dollar in Shanghai today, 0.6 percent weaker than the year-end median estimate of 6.10 in a Bloomberg News survey.

Selling Pressure

“We expect more selling pressure in the offshore yuan bond market, given a slowdown in capital inflows and a possible correction in the yuan spot,” said HSBC’s Zhao. “With weaker sentiment and tighter liquidity, some money managers are trimming their holdings in the yuan bond market.”

The State Administration of Foreign Exchange last month tightened yuan capital rules for banks and stepped up scrutiny of flows to prevent speculative funds from entering the country disguised as trade payments. New foreign-exchange loans dropped to $5.8 billion in May, according to the central bank. The average flow of funds since September was $20 billion, HSBC said in a note on June 10.

The currency’s advance against the dollar this year made it the best performer in emerging markets and the sole gainer in Asia. That compares with the Russian ruble’s 5.6 percent plunge and the Brazilian real’s 4.9 percent decline. India’s rupee fell

5.6 percent and touched a record low of 58.996 on June 11.

Slowing Economy

China’s industrial output growth slowed to 9.2 percent from a year earlier in May, less than the 9.4 percent forecast in a Bloomberg survey of economists. Exports rose the least in 10 months and factory-gate prices fell for a 15th month, official figures released this month show.

“There are already signs that the strength of the currency is potentially damaging China’s exports performance,” said Robert Minikin, a foreign-exchange strategist at Standard Chartered in Hong Kong. “We expect no further appreciation in the yuan by the end of the year, and see some risks it could weaken in the coming weeks and months.”

Analysts are paring their estimates for the country’s economic growth following the data. Barclays Plc. cut forecasts for this year and the next to 7.4 percent, from 7.9 percent and

8.1 percent, respectively. Australia and New Zealand Banking Group Ltd. trimmed its 2013 projection to 7.6 percent from 7.8 percent. Goldman Sachs Group Inc. and Nomura said they see downside risks to their forecasts. The World Bank today reduced its growth forecast for the world economy to 2.2 percent from a January estimate of 2.4 percent.

Band Widening

Premier Li Keqiang reiterated last month the country is making progress in liberalizing its capital account. Slower yuan gains could open the window for such reforms, including broadening the currency’s daily trading band, Paul Mackel, a Hong Kong-based strategist at HSBC, wrote in a June 10 note.

The People’s Bank of China sets a daily reference rate for the spot market in Shanghai, and limits the yuan’s moves to a maximum 1 percent on either side of the fixing.

China’s Finance Ministry will sell 13 billion yuan of bonds in Hong Kong on June 26 and 10 billion yuan more in the second half, it said on June 9. It will offer bonds with a 30-year tenor for the first time. Ten billion yuan of the bonds issued this month will be sold to institutional investors with the rest going to global central banks.

Declines in the yuan and related assets could be seen as a “buying opportunity” as the medium-term outlook for the currency is positive because China’s trade balance still looks healthy, according to Standard Chartered’s Minikin.

More Expensive

Five-year credit-default swaps protecting China’s sovereign debt rose 21 basis points this month to 107.5 in New York, the highest since Aug. 3, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent if a government or company fails to adhere to its debt agreements.

The one-year offshore yuan cross-currency swap rate, the fixed cost paid to exchange dollars into the currency, jumped 38 basis points this month to 2.6 percent, the highest since Dec. 28, Bloomberg data showed.

“The expectation of slower yuan appreciation impacts cross currency swap curves as they move higher, which in turn makes holding bonds more expensive,” said Vishal Goenka, Singapore-based head of local currency credit trading for Asia at Deutsche Bank AG. “Hence, Dim Sum bond yields should move higher. Higher interest rates and wider credit spreads may make some investment-grade bonds look overvalued.”