Bloomberg News

Best Forecasters Say Yuan to Gain, Boosting Bonds: China Credit

October 10, 2011

Oct. 10 (Bloomberg) -- The yuan will extend gains as China seeks to avert a trade war with the U.S., its most-accurate forecasters predict, bolstering demand for Chinese bonds.

The currency, which jumped the most since its 2005 revaluation today, will rise 0.8 percent to 6.3 per dollar by March 31, said Leong Sook Mei, the regional head of global foreign-exchange research at Bank of Tokyo Mitsubishi UFJ Ltd., the top forecaster in the six quarters ending Sept. 30. Commonwealth Bank of Australia, ranked second, expects a 1.1 percent advance to 6.28 by yearend. The yuan added 1.2 percent in the third quarter, the only one of 25 developing-nation currencies tracked by Bloomberg to climb.

China’s central bank said on Oct. 4 that the U.S. risks triggering a trade war through legislation that would punish the Asian nation for undervaluing its currency. Policy makers said they would continue to increase exchange-rate flexibility. Commonwealth Bank recommended investors buy yuan debt in Hong Kong, known as Dim Sum bonds, after an emerging-market selloff prompted average yields to almost double in seven months.

“Especially with pressure from the senators, Chinese authorities can still afford to set a stronger yuan for now,” Singapore-based Leong said in an Oct. 6 interview. “We are very Asian-currency bearish in the short term. One gift China can give to the rest of the world through the end of this year is to allow the yuan to be a bit stronger.”

The yuan climbed 0.6 percent to a 17-year closing of 6.3486 per dollar in Shanghai after the week-long National Day public holiday. Three-month non-deliverable forwards on China’s currency gained 0.7 percent last week, the most since August and added 0.3 percent today.

Export Outlook

In offshore markets, the currency added 0.3 percent to 6.3870 per dollar, after falling 2.1 percent in Hong Kong last month. The yuan is 0.8 percent weaker than the onshore rate, compared with a discount of 1.6 percent before the holiday. Brazil’s real slumped 17 percent in the third quarter, Russia’s ruble dropped 13 percent and India’s rupee weakened 8.7 percent, data compiled by Bloomberg show.

Bank of Tokyo-Mitsubishi had average margin of error of 0.45 percent on its yuan forecasts, according to data compiled by Bloomberg. Commonwealth Bank’s margin was 0.46 percent.

A faltering global recovery is curbing the outlook for exports in China, the world’s second-largest economy, and weakening most currencies against the dollar. The euro has dropped 7.1 percent against China’s currency since the end of August and the South Korean won slid 10 percent versus the yuan. The JPMorgan Nominal Effective Exchange Rate, a trade-weighted index for the yuan, climbed 4.7 percent in September, the most since December 1997, increasing the cost of goods made in China.

‘Good Opportunity’

Dim Sum debt fell 2.7 percent in the second half of 2011, erasing its 1.3 percent gain in the first six months of the year, according to an index compiled by HSBC Holdings Plc. The average yield on Dim Sum bonds surged to 3.65 percent on Oct. 7, up from a record-low 1.91 percent on Feb. 28, as investors scaled back expectations for yuan appreciation. That brought it in line with three-year government bond yields yielding 3.65 percent, Chinabond data show.

The sell-off in Dim Sum bonds is “a good opportunity to buy high-grade issues,” said Andy Ji, a currency strategist at Commonwealth Bank in Singapore. “There was a bubble in some pockets of the market and this had a lot to do with yuan appreciation expectations.”

Dalian Port (PDA) Co., the operator of China’s largest crude-oil terminal, is selling yuan-denominated bonds this month. The company, based in the northern Chinese city of Dalian, reported an 11 percent profit increase for 2010.

‘Continue Appreciation’

Policy makers won’t seek to stimulate growth by halting currency gains because that would push up the cost of commodity imports, Bank of Tokyo-Mitsubishi UFJ’s Leong said. Inflation eased to 6.1 percent in September from 6.2 percent the previous month, a report this week will say according to the median forecast of economists in a Bloomberg survey. Consumer prices gained 6.5 percent in July, the most in three years, official data show.

“They will continue appreciation, given the fact that inflation is still relatively high in China,” said Leong. “Clearly, the Chinese aren’t going to hike interest rates and so, the only other weapon they have is the yuan.”

China’s onshore 10-year government bond yield dropped 24 basis points, or 0.24 percentage point, in September, the first decline in four months, to 3.86 percent, the lowest level since June 8, according to Chinabond. The one-year offshore interest rate swap, the fixed cost needed to receive a floating payment, fell five basis points last week to 3.66 percent, and reached the lowest level since August. The rate rebounded 2.5 basis points today to 3.685 percent.

Presidential Campaign

The People’s Bank of China has raised interest rates five times in the past 12 months to combat inflation. Rising benchmark rates boosted the yield advantage on yuan government debt over similar-maturity U.S. Treasuries to 235 basis points on Sept. 22, the widest in at least four years. While the yuan has climbed 30 percent against the dollar in the past decade, the central bank has built up $3.2 trillion in reserves by purchasing dollars to slow the appreciation.

President Barack Obama, preparing for the 2012 presidential campaign, said on Oct. 6 in Washington that China has been aggressive in “gaming the trading system,” including intervening to keep the value of its currency artificially low. Obama warned that legislation in the Senate to penalize China risked triggering trade sanctions against the U.S. A final Senate vote on laws allowing U.S. companies to seek duties to compensate for the undervalued yuan is scheduled for this week.

‘Hot Issue’

“China’s yuan will be a hot issue toward the U.S. presidential election and China is aware of that risk,” said Dariusz Kowalczyk, a Hong Kong-based strategist at Credit Agricole CIB, the fourth most-accurate forecaster with a margin of error of 0.69 percent. “China will continue appreciating its currency preemptively.”

Credit Agricole predicts the yuan will gain to 6.3 per dollar by the end of the year. Only firms with at least four predictions were ranked.

A Chinese manufacturing index advanced for a second month in September and service industries expanded at a faster pace, data released in October showed. The yuan, up 3.8 percent in 2011, will appreciate between 4 percent and 5 percent this year, central bank adviser Li Daokui said last week. The economy will expand 8 percent to 9 percent a year, he said. Gross domestic product rose 9.5 percent in the second quarter after increasing 9.7 percent in the first three months, government data show.

Geo-Politics

Five-year credit-default swap contracts on China’s bonds fell 10 basis points to 164 basis points on Oct. 7, according to data provider CMA, which compiles prices quoted by dealers in the privately negotiated market. The contracts insure debt against non-payment, and traders use them to speculate on credit quality. An increase suggests deteriorating perceptions of creditworthiness and a drop shows improvement.

“As long as we don’t have a global recession, what will dominate China’s foreign-exchange policy is the geo-political considerations,” said Thomas Harr, the head of Asian currency strategy in Singapore at Standard Chartered Plc, the top forecaster for Asian currencies overall with a margin of error of 2.66 percent. “They do understand they have a role in the global economy to play there. The clear outperformer will be the yuan.”

The London-based bank expects China’s currency to strengthen to 6.31 per dollar by the end of 2011.

--With assistance from Mary Lowengard and Wei Lu in New York. Editors: Sandy Hendry, Ven Ram

To contact the reporters on this story: Yumi Teso in Bangkok at yteso1@bloomberg.net; Lilian Karunungan in Singapore at lkarunungan@bloomberg.net

To contact the editor responsible for this story: Sandy Hendry at shendry@bloomberg.net


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