Consequently, it would be prudent for investors in the Hong Kong bond market to be more cautious of putting their assets into yuan-denominated bonds.\u00a0 In this article, Xingjian Zhao takes a detailed look at the twists and turns that are happening in the Hong Kong yuan-denominated securities market, and offers an analysis particularly helpful to current and potential investors in this dynamic market.<\/p>\n
Until as recently as November 2011, most investors had viewed the Chinese yuan (also called the \u201cRenminbi\u201d) as a one-way bet to appreciate in value.\u00a0 But market sentiment has shifted decisively against expectations for the currency\u2019s continued rise. Significant changes to the yuan\u2019s trading pattern, coupled with reduced overall risk appetite in the global financial markets, now suggest that investors expect China to halt the currency\u2019s appreciation. And China may do just that \u2013 despite heightened U.S. pressure during an election year \u2013 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 \u201cDim Sum\u201d 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\u2019 minimal rates of return.<\/p>\n
Abundant risk appetite earlier this year had made the yuan\u2019s steady long-term rise seem inevitable. China\u2019s 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\u2019s 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 \u2013 the best performance among all Asian currencies except the yen. 1\u00a0 The PRC government even began negotiations toward an agreement with the Association of South East Asian Nations (\u201cASEAN\u201d) 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.<\/p>\n
Up till early November, the yuan often traded close to the PBOC\u2019s 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\u2019s 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\u2019s 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\u2019s current account bolster Beijing\u2019s argument that the yuan is no longer undervalued. China\u2019s 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 \u201c4% threshold\u201d proposed by some U.S. lawmakers as the baseline for assessing currency misalignment.<\/p>\n
Investors\u2019 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.<\/p>\n
Some argue that long-term bets should still favor the yuan\u2019s rise against the greenback. But recent trading patterns suggest that the market has already developed far more nuanced expectations about the yuan\u2019s future exchange rate \u2013 signaling a possible end to investors\u2019 honeymoon with the emerging but still tightly controlled currency.\u00a0 Unlike revenge, however, dim sum is not a dish that is best served cold.<\/p>\n
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1\u00a0\u00a0\u00a0\u00a0 The People\u2019s Bank of China (\u201cPBOC\u201d), the country\u2019s central bank, has kept a tight grip on the yuan\u2019s exchange rates with other currencies.\u00a0 It sets a daily \u201cparity rate\u201d for the yuan against the U.S. dollar, and limits the yuan\u2019s movement to a narrow band of no more than 0.5% above or below the government\u2019s daily rate.\u00a0 As a result, the PBOC effectively controls the yuan\u2019s exchange rate on any given day, causing analysts to deem the currency as one that is not fully convertible.<\/p>\n","protected":false},"excerpt":{"rendered":"