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Offshore bonds, easier rules drive demands for yuan
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The Chinese economy has gained the forefront of public attention and debates about its outlok remain elevated. Chinese data released in August raised expectations that economic growth will intensify, with hard landing fears up the spout.
These economic indicators implied that the yuan would resume its appreciation in the second half, buoyed by other elements.
We note that the yuan's move on economic condition changes is “asymmetrical.” The currency tends to rebound when economic conditions improve, while any worsening economic signs only cap the upside, not trigger selling pressure. That pattern is very similar to the behavior of the US dollar this year as the prospect of the Fed starting to withdraw its stimulus looms.
Any negative impact on the yuan from a Fed policy change is expected to be minimal. In the fixed income market, the recent narrowing of the yield spread between the “AA” and “AAA” rated securities demonstrates that the credit condition has been less critical. Offshore structure deposits are less speculative due to their lengthy holding period, and issuance grew at a much faster pace since the second quarter.
The yuan is widely accepted to have the highest degree of correlation with the performance of its offshore “dim sum” bond market. Since that market was launched in 2007, it has become one of the limited ways to directly access yuan-denominated assets, sparking offshore deposit rallies. For now, some divergence is likely to emerge. The “dim sum” market remains subdued amid lack of fresh impetus.
Total issuance from July to about mid-August was only 550 million yuan, compared with a monthly average of 8.1 billion yuan in the first half.
However, this "summer lull" maybe attributed to conjecture about the Fed’s stimulus withdrawal.
On the other hand, high-yield issuance from property developers may carry on, pushing the return higher for the entire offshore bond market. Record high property prices in China may continue to support the recent improving performance in the “dim sum” market.
Higher numbers of yuan corporate transactions reflect rapid demand on the currency as well. In June, the yuan ranked 11th in the world as a payments currency, up from 20th early last year, data from Swift showed.
The yuan could replace the Singapore dollar or Hong Kong dollar and become one of the top 10 world payments currencies after Shanghai recently created a new experimental free trade zone for promoting economic reforms.
Further relaxation of the rules governing China’s Qualified Foreign Institutional Investor and RMB Qualified Foreign Institutional Investor programs have helped effectively curb outflows of money, while other emerging markets are suffering from a flight of capital. The People’s Bank of China and the State Administration of Foreign Exchange have announced that the quota for QFII investment will be increased by US$70 billion, while RQFII will expand from Hong Kong to other places.
Worries that the underperformance of China’s A-share market will intimidate qualified foreign investor inflows aren’t founded because those funds tend to flow to stocks with higher dividends and not to chasing rapid capital gains. This could be the best explanation of “how the strongest currency survived in the worse-performing index.”
Jimmy Zhu is a Singapore-based senior economist of FX Primus, a foreign exchange brokerage with services covering 205 countries.
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