economic sector chinafx dbs 14jun11
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8/6/2019 Economic Sector ChinaFx DBS 14Jun11
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CNH: decoupling of CNY/CNH bond yields to continue July 18, 2011
CNH: decoupling of CNY/CNH bondyields to continueDBS Group Research 18 July 2011
Nathan Chow (852) 3668 5693 nathanchow@dbs.com
Interest rate strategy
Abundant liquidity and elevated commodity prices have driven China's inflationto a 35-month high of 6.4 percent. The People's Bank of China (PBoC) increasedinterest rates for the third time this year on July 6, making it clear that taminginflation is a top priority even while the economy moderates. As a result, onshorebond yields should continue their upward trend amidst ongoing monetary tightening.Offshore bond yields, however, could go the opposite direction.
Limited correlation between the onshore and offshore bond markets
Onshore renminbi (RMB) bonds are highly susceptible to changes in China'smonetary policy. During 2006-08, deposit rates were increased a number of timesin response to rising inflationary pressure. The 1-year deposit rate was raised189bps to 4.14% between Aug06 to Jan08, while 1-year China government bond(CGB) yields have increased 166 bp to 3.89%. Similarly, the PBoC has lowereddeposit rates during the financial crisis, and onshore bond yields fell (Chart 1).
This correlation between policy rates and bond yields has yet to be seen in theoffshore (CNH) market. Since Oct10, there have been nine upward adjustmentsin the RRR and five hikes in benchmark rates. Although the onshore 1-year CGBbond yields have risen correspondingly, offshore CGB bond yields have not.Instead, they had experienced their steepest decline (Chart 2).
CNH bond yields mainly driven by expectations of renminbi appreciation
Hong Kong's RMB deposits have surged on the back of renminbi settlement ofcross-border trade since mid-2010. The fast offshore funding accumulation, however,is not matched by sufficient increase in the supply of offshore RMB investmentproducts. With the five-fold increase in RMB deposits within one year to 548billion in May 2011, the outstanding amount of CNH bonds stands at only 149
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Latest: 18 Jul 2011
Chart 1: Onshore bond yields are highly correlated
with policy rates
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Latest: 18 Jul 2011
Chart 2: Weak correlation between onshore and
offshore bond yields
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CNH: decoupling of CNY/CNH bond yields to continue July 18, 2011
billion (Chart 3, 4). The low bond-to-deposit ratio (27%) has led to cheap fundingcost in the offshore market. The current low bond yield phenomenon underscoresthe fact that foreign investors have limited access to alternative CNH investmentproducts and the onshore bond market, which could offer higher yields. Forinstance, the latest three-year government bond issue is yielding only 1.0% inthe CNH market, compared with 3.3% for the onshore sovereign issue (Chart 5).Scarcity of CNH investment products amidst rising appreciation expectation ofthe renminbi thus depress offshore bond yields even though monetary tighteningcontinues onshore.
CNH bond yields will likely remain relatively low
As onshore liquidity will likely remain tight, the appetite for offshore fundingwill continue to grow. Offshore bond issuance should become more popular.Meanwhile, as discussed in "Time to re-engage in the CNH-NDF basis trade"(27Jun11), the latest clarification of RMB FDI transactions should prompt morecompanies to issue CNH bonds. Indeed, many enterprises have already announcedsuch plans and, to our knowledge, the Ministry of Finance is planning its thirdoffshore issuance in Hong Kong. As of June, the gross issuance of CNH bondsstands at 90 billion. It will not be a surprise if it surpasses 150 billion by year-end. Meanwhile, the growth momentum of RMB deposits in Hong Kong willremain strong. Currently only7 percent of China's tradeis settled in renminbi
(compared with 95 percentof US's exports and 40 percentof Japan's exports invoicedin USD and JPY), and thereis still a significant scope forexpanding the size of cross-border RMB settlement (Chart6). Indeed, it has been reportedthat the PBoC aims to expandits cross-border settlementplan nationwide this year.The bond-to-deposit ratiois thus expected to remain
low to keep funding costslow.
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Chart 3: HK's Renminbi deposits outstanding Chart 4: CNH bond outstanding
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Offshore sovereign bond
Onshore sovereign bond
Chart 5: Onshore vs offshore sovereign bond yields
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CNH: decoupling of CNY/CNH bond yields to continue July 18, 2011
In addition, China's2QGDP growth turnedout to be better thanexpectated, easingconcerns of a hard
landing. The resilienceof the economy suggestspolicymakers can affordmore tightening in 2H11.Stronger rate hikeexpectations in turnsupports further renminbiappreciation. Moreover,US Fed chairman BenBernanke recently saidthat the Fed wouldconsider additionalstimulus if the US
economic conditionscontinue to worsen. Further US easing would likely bring dollar depreciationagainst major currencies and commodity prices would likely rebound, fuelingthe risk of further imported inflation in China. As a result, the demand forRMB-denominated assets will remain robust and that should keep CNH bondyields from rising significantly. It appears that decoupling of onshore and offshorebond yields is set to continue.
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Chart 6: % of exports invoiced in exporter home
currency
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CNH: decoupling of CNY/CNH bond yields to continue July 18, 2011
Recent research
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