Bloomberg News

Yuan Traders Diverge With Senate on Exchange Rate: China Credit

October 13, 2011

Oct. 13 (Bloomberg) -- At a time when U.S. lawmakers are closer than ever to punishing China for having an undervalued currency, trading in Hong Kong suggests the yuan is too strong.

The currency sank as much as 1.1 percent to 6.5463 per dollar in the city yesterday, a record 2.4 percent discount to the prevailing Shanghai rate, data compiled by Bloomberg show. The yuan has traded at a discount for almost four weeks, undercutting the onshore rate by 1 percent on average, as Europe’s debt crisis spurs demand for dollars. The premium investors demand to hold China’s dollar-denominated debt instead of U.S. Treasuries widened 43 basis points in the past month to 268 basis points, based on a JPMorgan Chase & Co. index.

The Senate passed a bill on Oct. 11 that would allow sanctions on countries with misaligned exchange rates. China’s Foreign Ministry, the biggest holder of Treasuries, said the proposed legislation is “protectionism” that would put the global economy at risk. The yuan gained 18 percent in the past four years, the most among 25 emerging-market currencies.

“Global investors are seeing problems in China’s economy and it’s not sensible to accelerate appreciation now,” said Ronald Wan, a Hong Kong-based managing director at China Merchants Securities Co., a unit of the nation’s sixth-biggest bank by market value. “Advocating a stronger yuan to create jobs and help the economy might have an audience in the U.S. but it’s not convincing investors. The bill is a political gesture.”

‘Gaming’ the System

U.S. Treasury Secretary Timothy F. Geithner said on Oct. 11 in Washington that China must move more quickly to allow its currency to appreciate and that he’s “very supportive” of the objectives of the Senate’s bill. The Asian nation has been aggressive in “gaming the trading system,” including intervening to keep the value of its currency artificially low, President Barack Obama said last week, when Chinese financial markets were shut for a holiday.

European Union Trade Commissioner Karel De Gucht said today in Seoul that China should revalue the yuan further as the currency doesn’t accurately reflect the nation’s economy.

The currency fell 0.4 percent to 6.3820 per dollar as of the close in Shanghai, after a 0.1 percent decline in September that was the first monthly loss since January, according to the China Foreign Exchange Trade System. Gains were halted for almost two years during the global financial crisis to support the local economy, and data due next week is forecast to show slower growth gross domestic product.

Managed Currency

The world’s biggest exporting nation is facing the risk of its two largest markets, the European Union and the U.S., falling back into recession. China’s overseas sales increased 17.1 percent in September, the least since February, according to trade data released today. GDP growth cooled to a two-year low of 9.3 percent in the third quarter, according to the median estimate in a Bloomberg News survey of economists before data due next week.

China is allowing greater use of its currency in global trade and investment to reduce reliance on the dollar. Vice Premier Li Keqiang outlined a range of measures to boost Hong Kong’s status as an offshore yuan trading center in August, including rules allowing holdings of the currency in the city to be used for foreign direct investment in China.

The central bank limits conversion of the yuan onshore for investment purposes and restricts daily movements to 0.5 percent from its daily fixing. Intervention by buying and selling the currency has contributed to the buildup of $3.2 trillion of foreign-exchange reserves. Chinese investors hold $1.2 trillion of Treasuries.

Smaller Gains

“Softer growth would mean less official appetite for fast yuan appreciation,” said Sean Callow, a senior currency strategist at Westpac Banking Corp. in Sydney. “The offshore yuan is showing that it is not a one-way bet.”

Westpac predicts that the yuan will appreciate 2.3 percent to 6.24 per dollar by the end of 2012 in Shanghai, the most bearish of 18 forecasts in a Bloomberg survey. The median projection is for a move to 6.06.

The currency dropped 0.6 percent to 6.460 per dollar today in Hong Kong, a 1.2 percent discount to the onshore rate. It reached 6.3495 on Sept. 1, the strongest level since offshore trading commenced in July last year. A level of 6.56 on Sept. 23 was the weakest since March.

“We’ve seen very big gyrations in risk appetite quite recently,” said Mitul Kotecha, head of global currency strategy at Credit Agricole CIB in Hong Kong. “We might see a little bit of moderation in the pace of appreciation if uncertainties persist. I don’t think we’ll go back to a re-pegging.”

Rising Yields

The yuan advanced 1.2 percent against the dollar in the third quarter, while Brazil’s real slumped 17 percent, Russia’s ruble dropped 13 percent and India’s rupee weakened 8.7 percent, data compiled by Bloomberg show. The U.S. currency strengthened versus 15 of 16 major currencies during the period.

Bleaker prospects for yuan gains are sapping demand for Dim Sum bonds, debt denominated in the currency that trades in Hong Kong. The average yield on the securities jumped 81 basis points, or 0.81 percentage point, in the past month to 3.60 percent, an HSBC index shows.

Yields on Chinese 10-year government bonds were unchanged at 3.80 percent today, Chinabond data show. The average yield on similar-maturity top-rated corporate debt was also little changed at 6.13 percent.

Bond Risk

Five-year credit-default swap insuring against a default on China’s bonds fell 13 basis points to 146 basis points yesterday, according to data provider CMA, which compiles prices quoted by dealers in the privately negotiated market. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.

Under the bill approved by the U.S. Senate, governments that undervalue their currencies would face penalties, including increased dumping duties. House Speaker John Boehner has said the measure risks starting a trade war and urged President Obama to oppose the legislation.

“Raising the currency bill at this point is inappropriate as the U.S. is undergoing a weak recovery and the market isn’t betting on strong appreciation anymore,” said Shen Jianguang, a Hong Kong-based economist at Mizuho Securities Asia Ltd., who has worked for the International Monetary Fund and the European Central Bank. “In the near term, the yuan exchange rate also needs to take into account whether exporters can bear a stronger currency.”

--Editors: James Regan, Sandy Hendry

To contact the reporters on this story: Fion Li in Hong Kong at fli59@bloomberg.net; Kyoungwha Kim in Beijing at kkim19@bloomberg.net

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


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