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Yuan Bond Yield Beating Australia Lures Schroders: China Credit

December 05, 2012

Yuan Bond Yield Beating Australia Lures Schroders

The yuan has climbed 18.7 percent against the dollar in the past five years, just shy of the 21 percent gain in the Australian dollar, supporting Premier Wen Jiabao’s bid to shift the economy’s focus to domestic consumption from exports. Photographer: Stefen Chow/Bloomberg

The yield on China’s 10-year bonds is higher than Australia’s for the first time in at least a decade, a reversal that investors say will boost the yuan against the South Pacific nation’s currency.

China’s benchmark notes yield 3.55 percent, 37 basis points more than similar-maturity debt in Australia, compared with 71 basis points less in March. The average discount since Bloomberg started compiling data on yuan notes in early 2003 is 155. Schroders Plc (SDR) said it cut exposure to Australian dollars in favor of China’s currency, while Commonwealth Bank of Australia said the yuan is a good hedge against volatile global markets.

The yuan has climbed 18.7 percent against the dollar in the past five years, just shy of the 21 percent gain in the Australian dollar, supporting Premier Wen Jiabao’s bid to shift the economy’s focus to domestic consumption from exports. The Aussie rose 0.4 percent this quarter, lagging the yuan’s 1 percent advance, as the Reserve Bank of Australia cut interest rates this week, for the sixth reduction in 14 months.

“Should the yield support become less favorable the Australian dollar could see downward pressure,” Bob Jolly, London-based head of global macro at Schroders, which oversees $327 billion, said in a Dec. 3 interview. “Chinese authorities are expected to gradually move the yuan higher as the economy rotates toward domestic consumption over investment and exports. This may also damp the demand for hard commodities, one of Australia’s major exports.”

Rates Diverge

The People’s Bank of China has refrained from cutting its benchmark 3 percent deposit rate since July as exports, factory production and retail sales accelerated in October.

The RBA has conducted the most-aggressive monetary easing in the developed world since November 2011 as the currency’s 63 percent advance in the past four years hurt exports, manufacturers and tourism. Swap contracts show a 70 percent chance policy makers will cut the overnight cash-rate target to 2.75 percent or less by March from 3 percent now.

China’s bond risk has dropped relative to Australia’s to the lowest in almost two years. The South Pacific nation has the top Aaa rating from Moody’s Investors Service, while China is ranked Aa3, the fourth-highest investment grade.

Bond Risk

Credit-default swaps protecting China’s sovereign debt against non-payment for five years fell 88 basis points this year to 59 yesterday, CMA prices show. The contracts were 15 basis points higher than those for Australia on Nov. 6, the lowest level since December 2010.

Australia’s economy was bolstered as Chinese-led demand for iron ore, coal and natural gas surged, in part because of Beijing’s 4 trillion yuan ($643 billion) stimulus package during the global financial crisis in 2008. China, which is now trying to boost consumption while avoiding investment bubbles, cut this year’s expansion target to 7.5 percent from the 8 percent goal in place since 2005.

Exports of iron ore to China fell to a 19-month low in September, helping drive Australia’s unemployment rate to a 2 1/2-year high of 5.4 percent in September and October. Prices of iron ore dropped 16 percent this year.

“The yield advantage of the Australian dollar has subsided enough for investors to think what are the opportunities elsewhere,” said Andy Ji, a Singapore-based foreign-exchange strategist at Commonwealth Bank of Australia (CBA), the nation’s largest lender by market value. “We’re seeing overwhelming demand for the Chinese yuan.”

Lower Volatility

The yuan’s low volatility also makes it a more attractive currency to hedge against the risk the U.S. fiscal deficit may trigger a recession, Ji said. The divided U.S. Congress has to strike a deal before the so-called fiscal cliff of automatic tax increases and spending cuts are due to start in the first three months of 2013.

One-month implied volatility for the yuan, a measure of expected moves in exchange rates used to price options, was at 1.53 percent yesterday, compared with Australia’s 6.1 percent.

“The yuan is pretty good in terms of hedging against this so-called fiscal cliff because the currency is more or less pegged to the U.S. dollar but still has a sort of appreciation pace,” Ji said. “The Aussie is a free-floating currency.”

Dim Sum Bonds

While Australia provides a wider range of top-rated assets, Hong Kong’s Dim Sum bond market is increasingly offering attractive yields as long as buyers are selective, said Adam K. Tejpaul, managing director for the investment business of JP Morgan Chase & Co.’s private bank unit in Asia. The average yield on yuan denominated debt in Hong Kong has climbed to 4.76 percent from 2.03 percent at the start of 2011, according to a Bank of China Ltd. index.

“As clients move away from dollars in Asia the Aussie and the offshore yuan are two of the most-favored,” Tejpaul said. “In our cash holdings, these two currencies are now about equal.”

China’s much-larger economy growing at a moderately slower pace is still a very powerful growth driver for Australia, which should help make its currency resilient, Rob Subarraman, the Hong Kong-based chief economist and head of fixed-income research for Asia ex-Japan at Nomura Holdings Inc., said in an interview in Singapore on Dec. 4.

Fortunes Tied

“So long as China does not have this hard landing, Australia is going to hold up,” he said. “Australia has good fundamentals. The debt has attracted a lot of sovereign wealth, central bank flows, which are a stable source of financing.”

Australia’s economic growth cooled to 3.1 percent last quarter from a year earlier after a revised 3.8 percent expansion in the April-June period, official data showed yesterday. China grew 7.4 percent in the three months to September, slowing for the seventh consecutive quarter.

The South Pacific nation’s domestic product growth will slacken to 2.8 percent in 2013 from 3.5 percent this year, according to the median estimate of 31 economists in a Bloomberg survey. China’s will accelerate to 8.1 percent from 7.7 percent, a separate survey shows.

“As China shifts from exports and investment to consumption, Australia will become less of a beneficiary from the rise of China in the next 10 years than in the last 10 years,” Stephen Jen, the managing partner at hedge fund SLJ Macro Partners LLP in London, said in an interview on Dec. 3. “The yuan is close to its fair value, but not likely to be considered overvalued by Beijing, while the Australian dollar is considered overvalued by the RBA.”

To contact the reporter on this story: Lilian Karunungan in Singapore at lkarunungan@bloomberg.net

To contact the editor responsible for this story: James Regan at jregan19@bloomberg.net


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