Bad Dim Sum: Lowered Risk Appetite Hampering Yuan's Rise

by Michael Diaz Jr. - Diaz Reus International Law Firm
Contact

Until as recently as November 2011, most investors had viewed the Chinese yuan (also called the “Renminbi”) as a one-way bet to appreciate in value.  But market sentiment has shifted decisively against expectations for the currency’s continued rise. Significant changes to the yuan’s trading pattern, coupled with reduced overall risk appetite in the global financial markets, now suggest that investors expect China to halt the currency’s appreciation. And China may do just that – despite heightened U.S. pressure during an election year – in the face of reduced inflation, a cooling domestic housing market, and slowing economic growth. This is particularly bad news for investors in so-called “Dim Sum” bonds, low-yield yuan-denominated bonds sold in Hong Kong embedded with the unwritten promise that the steady upward march of the yuan will always offset the bonds’ minimal rates of return.

Abundant risk appetite earlier this year had made the yuan’s steady long-term rise seem inevitable. China’s economy was booming, and so was its housing market. Foreign direct investment and industrial output were at record highs, while the export sector thrived. Chinese policymakers steadily appreciated the yuan to cool rising inflation and contain the housing bubble, both of which can lead to social unrest if left unchecked. Until last month, China’s central bank had engineered the yuan to rise at an average of almost half a percentage point a month, causing it to gain more than 3.5% against the U.S. dollar this year – the best performance among all Asian currencies except the yen. 1  The PRC government even began negotiations toward an agreement with the Association of South East Asian Nations (“ASEAN”) to settle cross-border trade in yuan, instead of the traditional greenback. Such bullish sentiment acted as a lure for droves of irrationally exuberant investors, who entered the market with the undue expectation that the yuan would have nowhere to go but up.

Up till early November, the yuan often traded close to the PBOC’s gradually rising daily parity rate. But since then, traders have pushed the currency to the bottom of its daily trading band (half a percent below parity) at some point during nearly every trading session. In an abrupt reversal, investors are now betting that slowing exports and cooling inflation will prompt the government to slow or stop the yuan’s appreciation, in order to help fledging small businesses weather the storm. Only steady yuan purchases by the PBOC have kept the value of the currency stable. This echoes a similar pattern of volatility in Hong Kong’s offshore yuan derivatives market. That new market, in which the currency is allowed to float freely, has been implying future yuan depreciation since late September. Recently released data on China’s current account bolster Beijing’s argument that the yuan is no longer undervalued. China’s current account surplus for the first three quarters of 2011 only comprised 3% of its GDP, down from 5.1% during the same period the year before. This is below the “4% threshold” proposed by some U.S. lawmakers as the baseline for assessing currency misalignment.

Investors’ appetite for dim sum suddenly soured. Realizing that they now have far less to gain from favorable exchange rate movements, investors are demanding far higher yields on their bonds. For example, Hong Kong-based yuan-denominated PRC government bonds issued this August with a 0.6% rate now trade two-and-a-half times higher, at a previously unthinkable yield of more than 1.5% (higher yields indicate weaker bond demand). Meanwhile, a closely followed index for offshore yuan-denominated bonds has fallen nearly 7% from its mid-year high, the same period over which expectations for continued yuan appreciation have faded. Alternatives for investing in yuan-denominated debt have also played a role in pushing up yields on dim sum bonds. The government of Hunan province in south-central China, for example, has recently sought a 10 billion yuan ($1.57 billion USD) syndicated loan in the Hong Kong market. Analysts predict that increased competition among offshore yuan issuers will lead to even greater pressure for them to offer higher yields. But higher yields and lower exchange rates strip dim sum bonds of their intended allure, making them look more and more like just plain-old government bonds.

Some argue that long-term bets should still favor the yuan’s rise against the greenback. But recent trading patterns suggest that the market has already developed far more nuanced expectations about the yuan’s future exchange rate – signaling a possible end to investors’ honeymoon with the emerging but still tightly controlled currency.  Unlike revenge, however, dim sum is not a dish that is best served cold.

_________________________________

 1     The People’s Bank of China (“PBOC”), the country’s central bank, has kept a tight grip on the yuan’s exchange rates with other currencies.  It sets a daily “parity rate” for the yuan against the U.S. dollar, and limits the yuan’s movement to a narrow band of no more than 0.5% above or below the government’s daily rate.  As a result, the PBOC effectively controls the yuan’s exchange rate on any given day, causing analysts to deem the currency as one that is not fully convertible.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Michael Diaz Jr. - Diaz Reus International Law Firm | Attorney Advertising

Written by:

Michael Diaz Jr. - Diaz Reus International Law Firm
Contact
more
less

Michael Diaz Jr. - Diaz Reus International Law Firm on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.
Feedback? Tell us what you think of the new jdsupra.com!