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Dec. 11 (Bloomberg) -- Chinese government bonds are offering investors record yield premiums over U.S. Treasuries, boosting demand for the yuan among private banks in Asia.
The difference for one-year notes averaged 380 basis points this quarter and reached 418 on Nov. 21, the highest in Bloomberg data going back to June 2005. The spread was 219 on average in the past five years. The yuan will strengthen 1.2 percent versus the dollar by the end of next year, based on the median estimate of analysts surveyed by Bloomberg.
The private banking arms of Societe Generale SA, JPMorgan Chase & Co. and Credit Suisse Group AG are all betting that China’s currency will extend its gains from a 20-year high because the world’s second-largest economy is strong enough to withstand a cut in stimulus by the Federal Reserve. The yuan’s Sharpe ratio, which measures investor returns adjusted for price swings, was 6.4 percent for the year, compared with Argentina’s 14.5 percent, according to data compiled by Bloomberg.
“Chinese onshore government bonds seem attractive in terms of both carry and potential currency appreciation,” Ben Sy, head of fixed income at J.P. Morgan Private Bank in Hong Kong said in a phone interview yesterday. “The yields are relatively high, compared with any major currencies, especially the U.S. dollar. The short-end yield gap is the widest and the most attractive.”
He added that many investors are constrained by quota limitations under the Renminbi Foreign Qualified Institutional Investor program, which allows investors to use offshore yuan to buy domestic bonds, stocks and money-market instruments.
The yield on government bonds due in a year has climbed 63 basis points to 4.23 percent this quarter, according to data compiled by Bloomberg. It reached a record 4.29 percent on Nov. 21, after People’s Bank of China Governor Zhou Xiaochuan said the monetary authority will allow market-based banking rates in the medium term. The rate on one-year U.S. Treasuries rose five basis points to 0.132 percent since the end of September.
Signs of a rebound in China’s economy are adding to the pressure on borrowing costs, with exports rising at the fastest pace in seven months in November and the nation’s trade surplus swelling to the largest in more than four years to $33.8 billion. The Purchasing Managers’ Index was 51.4 in November, unchanged from the 18-month high reached in October, official data on Dec. 1 showed.
China’s leadership listed several policy objectives after a Nov. 9-12 Communist Party meeting, including allowing markets a “decisive” role in the allocation of resources, freeing up of interest rates and accelerating moves to make the yuan more convertible. The currency has gained 2.6 percent against the dollar this year, the best performer in Asia. It touched 6.0703 per dollar yesterday, the strongest level since the government unified the official and market exchange rates at the end of 1993. It fell 0.01 percent to 6.0714 as of 10:02 a.m. in Shanghai today.
The nation introduced negotiable certificates of deposits in the interbank market this month as part of plans to loosen controls over interest rates. Cash demand at banks tend to increase before the Lunar New Year, which falls on Jan. 31 next year. The PBOC will free deposit rates when banks are able to use a new benchmark, such as the seven-day repurchase rate or a Shanghai interbank offered rate, as a gauge of funding costs, Deputy Governor Yi Gang said in an interview with the official Xinhua News Agency published Nov. 26.
“Several recent regulatory announcements have contributed to a sell-off in Chinese interest rates,” Barclays Plc strategists Igor Arsenin, Hamish Pepper and Nick Verdi wrote in a note yesterday. “Even though the levels are very high by historical standards, we believe the risk for yields is to the upside ahead of the year-end and Chinese New Year.”
The nation faces “relatively high” pressure from capital inflows because of loose monetary policy in the U.S. and Japan, as well as yuan appreciation expectations, the PBOC’s Yi said in an interview with Caixin’s New Century magazine on Dec. 2. Yuan positions at China’s financial institutions accumulated from foreign-exchange sales, a barometer of capital flows, climbed the most in nine months in October. The positions rose 441.6 billion yuan ($73 billion) to 28 trillion yuan, the highest in official data going back to 2000.
Capital flows disguised as trade could be boosting export numbers, a practice that authorities tried to crack down on in May, Nomura Holdings Inc’s Hong Kong-based economist Zhang Zhiwei wrote in a Dec. 10 note to clients. Banks should prevent companies from obtaining trade financing based on fabricated trades, the State Administration of Foreign Exchange said on its website on Dec. 8.
“China’s sovereign bond yields have risen to levels that are attractive internationally,” Xie Jun, a Guangzhou-based fund manager at GF Fund Management Co., said in a phone interview yesterday. “For investors in Hong Kong, there shouldn’t be big concerns in the near future as the yuan will continue its appreciation trend against the dollar.”
Credit-default swaps insuring China’s debt against non- payment have dropped 22 basis points this quarter to 67 in New York on Dec. 10, lower than an average of 81 in the past year, according to CMA prices.
Fan Cheuk Wan, chief investment officer for Asia-Pacific at Credit Suisse’s private banking and wealth management unit, said in a Nov. 26 interview that bolder reforms than the market expected will spur demand for Chinese assets even as the economy slows. She predicts 7.5 percent economic growth in 2014, slowing from 7.7 percent this year.
The yuan is the bank’s top Asian currency pick with a 12- month target of 6.00 per dollar. Southeast Asia and India remain vulnerable to tapering concerns, the bank said in a Nov. 25 report.
“In the next 12 months, we are likely to see the less controversial reforms program get executed,” said Fan. “This would help address part of the structural headwinds faced by the Chinese economy.”
China started the RQFII program in 2011 in Hong Kong. Regulators said this year they would expand it to Taiwan, the U.K. and Singapore. London received an 80 billion yuan RQFII quota in October while Singapore got a 50 billion yuan quota.
“Onshore government bond yields are increasingly attractive,” said Peter Lee, Hong Kong-based head of Asian fixed income at Societe Generale’s private banking unit. “I don’t see any defaults or big changes in large-scale state-owned enterprises in 2014. If you have RQFII, such high rates on one- year government bonds offer very good value.”
--Editors: Robin Ganguly, Sandy Hendry