Top Forecaster Sees $4 Trillion Reason to Buy Yuan: China Credit

China’s yuan is poised to rally as data show an improving economy and a trade surplus that may push foreign-exchange reserves above $4 trillion, the currency’s top forecaster said.

Nomura Holdings Inc., which had the best estimates over the past four quarters as measured by Bloomberg Rankings, expects a 2.1 percent gain to 6.07 per dollar by Dec. 31. Second-ranked Credit Suisse Group AG predicts a year-end exchange rate of 6.10. The yuan gained 0.2 percent in the three months ended June, trimming its 2014 loss to 2.4 percent. The currency climbed 0.1 percent today to 6.1963 in Shanghai and touched a three-month high of 6.1940.

China is showing signs of an economic recovery as the central bank encourages lending to smaller businesses, with manufacturing growing at the fastest pace this year in June and the Shanghai Composite Index of shares rising 4.2 percent from this year’s low. Data in the coming week may show exports expanded the most since January, reserves reached $3.98 trillion and the trade surplus grew to the widest since 2009.

“The stars are aligning,” said Craig Chan, Nomura’s Singapore-based head of foreign-exchange strategy for Asia ex-Japan. “The trade balance is going to be strong. The second-quarter foreign-exchange reserves will definitely be a record, and there is a good chance they may break through the $4 trillion mark.”

Political Pressure

Exports rose 10.4 percent from a year earlier in June, compared with a 7 percent gain in May and a 6.6 percent decline in March, according to the median estimate in a Bloomberg survey before data due tomorrow. The trade surplus was probably $36.95 billion, another poll showed. China may announce the latest foreign-exchange reserve figures as soon as tomorrow.

The U.S. and China started two days of talks today in a summit called the Strategic and Economic Dialogue. American leaders have been longtime critics of China’s currency policy, saying the yuan is kept artificially weak to boost overseas shipments. The nations will have “frank” talks over the exchange rate and opening up of financial markets, Zhu Guangyao, China’s Vice Minister of Finance, said on July 7.

“If Chinese exports are improving, and the trade balance with the United States is moving in China’s favor, it’s not really geopolitically sustainable to imagine the currency will be unchanged or depreciate,” said Ray Farris, Singapore-based global head of currency strategy at Credit Suisse. “My guess is they will go back to allow some appreciation.”

Policy Change

After almost uninterrupted annual gains since 2005 that saw the yuan strengthen 33 percent versus the dollar, speculators had come to see the currency as a one-way trade, leaving the world’s second-largest economy vulnerable to a sudden shift in sentiment. This led policy makers to seek depreciation this year to discourage wagers and arrest a slide in exports. Now, with the economy improving and overseas shipments recovering, the currency has rebounded.

The yuan has advanced 0.9 percent in the past month. Non-deliverable forwards due in 12 months rose 0.02 percent today to 6.2460 per dollar in Hong Kong. The onshore rate will trade at 6.15 by the end of this year, implying a 0.8 percent appreciation, according to the median estimate in a Bloomberg survey of analysts.

Yuan Assets

The potential gains will spur demand for assets denominated in the Chinese currency, Nomura’s Chan said. The average yield on Dim Sum bonds fell 27 basis points in the second quarter, according to an index compiled by HSBC Holdings Plc. It was at 4.15 percent yesterday.

About 361 billion yuan ($58.3 billion) of Dim Sum bonds, or notes in the Chinese currency issued offshore, have been sold so far this year, close to last year’s total of 372 billion yuan, according to data compiled by Bloomberg. HSBC, the top underwriter of the securities, expects sales to reach as much as 570 billion yuan this year. South Korea and China last week signed an agreement to support Dim Sum bond issuance.

“A better outlook for China’s economy and the yuan is boosting demand for Dim Sum bonds,” said Ben Yuen, Hong Kong-based head of fixed income at BOCHK Asset Management, which manages about $3.1 billion in assets. “We are cutting our exposure to dollar bonds and taking the opportunity to buy more Dim Sum notes.”

Economic Risks

While the average yield on offshore yuan securities could slip below 4 percent this year, the scope for further declines is limited because of strong supply of new notes and the potential for higher U.S. Treasury rates, Yuen said.

The Federal Reserve may raise interest rates as soon as the first quarter, according to Landesbank Baden-Wuerttemberg, the most-accurate overall forecaster for major currencies. The gap between 10-year sovereign bonds in China and the U.S. has narrowed 24 basis points since the end of March to 155 basis points this week, data compiled by Bloomberg show.

A slowdown in China’s property market is among the risks to economic expansion, with data last month showing new-home prices in May fell in half of the 70 cities tracked by the government, the most in two years. The economy will expand 7.4 percent this year, the slowest pace since 1990, according to the median estimate in a Bloomberg survey.

The government has “the financing to prevent any systemic risks,” said Nomura’s Chan. “The currency, in our view, is still undervalued. It has become more and more undervalued because of this year’s drop relative to its trading partners.”

China appointed three clearing banks in London, Frankfurt and Seoul in the past month to promote use of its currency, the renminbi, in trade and finance. Germany will get an 80 billion yuan quota under the Renminbi Qualified Foreign Institutional Investor program, which allows foreign financial institutions to buy securities in China’s onshore market with yuan obtained overseas. Global RQFII quotas now total 640 billion yuan.

“The demand for renminbi as a global reserve currency and an asset which real money wants to own is going to increase,” said Chan.

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