economic sector chinafx dbs 14jun11

8/6/2019 Economic Sector ChinaFx DBS 14Jun11

1/4

1

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 [email protected]

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

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.04.5

Oct-05 Oct-06 Oct-07 Oct-08 Oct-09 Oct-10

%

1Y deposit rate CGB (1Y, onshore)

Latest: 18 Jul 2011

Chart 1: Onshore bond yields are highly correlated

with policy rates

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.54.0

Oct-10 Dec-10 Feb-11 Apr-11 Jun-11

%

CGB (1Y, offshore) CGB (1Y, onshore)

Latest: 18 Jul 2011

Chart 2: Weak correlation between onshore and

offshore bond yields


2/4

2


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.

0

100

200

300

400

500

600

Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11

CNY bn

Latest: May 2011

Chart 3: HK's Renminbi deposits outstanding Chart 4: CNH bond outstanding

0

20

40

60

80

100

120

140

160

2008 2009 2010 2011 YTD

CNY bn

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

3 Y 5 Y 10 Y

%

Offshore sovereign bond

Onshore sovereign bond

Chart 5: Onshore vs offshore sovereign bond yields


3/4

3


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.

0

20

40

60

80

100

US UK EU JP Malay Korea China

%

Chart 6: % of exports invoiced in exporter home

currency


4/4

4


Recent research

Disclaimer:

The information herein is published by DBS Bank Ltd (the Company). It is based on information obtained from sources believed to bereliable, but the Company does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness orcorrectness for any particular purpose. Opinions expressed are subject to change without notice. Any recommendation contained hereindoes not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. Theinformation herein is published for the information of addressees only and is not to be taken in substitution for the exercise of judgementby addressees, who should obtain separate legal or financial advice. The Company, or any of its related companies or any individualsconnected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss ordamages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent orotherwise) or further communication thereof, even if the Company or any other person has been advised of the possibility thereof. Theinformation herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or otherfinancial instruments or to provide any investment advice or services. The Company and its associates, their directors, officers and/oremployees may have positions or other interests in, and may effect transactions in securities mentioned herein and may also perform orseek to perform broking, investment banking and other banking or financial services for these companies. The information herein is notintended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary tolaw or regulation.

SG: A well-calibrated budget 21 Feb 11

CN: Inflation and labor productivity 21 Feb 11

CN: CNY capital account liberalisation -recent 8 Feb 11developments and implications

ID: Interest Rate Outlook & Strategy 2 Feb 11

TW: Appreciation impact 28 Jan 11

IN: Food inflation demand-driven 24 Jan 11

SG: Budget to tackle the gap 17 Jan 11

US: Interest Rate Outlook & Strategy 11 Jan 11

SG: Singapore attempts the impossible 6 Dec 10

SG: 2011: Above expectations 29 Nov 10

KR: Interest Rate Outlook & Strategy 11 Nov 10

EUR: One for the bulls 11 Nov 10

KRW: Stronger than consensus 3 Nov 10

ID: 2011 budget preview 1 Nov 10

Asia: Interest Rate Outlook & Strategy 28 Oct 10

IN: Higher rates or higher inflation 26 Oct 10

Asia: The six ways to absorb capital inflow 26 Oct 10

MY: A step towards Vision 2020 18 Oct 10

IN: Rising growth potential 13 Oct 10

ID: Inflows & monetary policy 13 Oct 10

SG: Its payback time 11 Oct 10

ID: Inflows drown fundamentals 8 Oct 10

Asia: Another day, another $2bn of inflow 7 Oct 10

SGD: Higher with or without tightening 7 Oct 10

ID: Subsidy saved, subsidy earned 5 Jul 11

JP: Recovery gathers steam 1 Jul 11

VN: Growing pains 28 Jun 11

CNH: Time to re-engage in the CNH-NDF 27 Jun 11basis trade

CN: How likely is a hard landing? 27 Jun 11

PH: Weathering headwinds 24 Jun 11

Tactical Regional Asset Allocation 15 Jun 11

ID: Indonesia FDI: more coming, more needed 14 Jun 11

Asia: Food prices and income inequality 6 Jun 11

in Asia

CN: A case study of price control on 20 May 11electricity

CN: Good value in CNY forwards 18 May 11

US: Interest Rate Outlook & Strategy 11 May 11

CN: Latent risks facing China 9 May 11

SG: Election effect on policy 9 May 11

HK: Mild tightening at work 15 Apr 11

KR: Interest Rate Outlook & Strategy 11 Apr 11

ID: The balance of payments outlook 8 Apr 11

FX: The CNH & its role in yuan reforms 7 Apr 11

CN: The formation of Chinese wealth 1 Apr 11

CN: Interest Rate Outlook & Strategy 31 Mar 11

CN: The roller coaster ride continues 28 Mar 11

CN: Offshore CNY progress check 24 Mar 11

2Q11 Tactical Regional Asset Allocation 23 Mar 11

economic sector chinafx dbs 14jun11

Documents