Collateral harm from a mechanism used by the People's Bank of China to defend the yuan may include a decline in demand from bond buyers who wish to hedge their currency risk. The premium dollar-based investors once received for exchanging their US currency has vanished as a result of the PBOC raising foreign yuan funding …
Collateral harm from a mechanism used by the People’s Bank of China to defend the yuan may include a decline in demand from bond buyers who wish to hedge their currency risk. The premium dollar-based investors once received for exchanging their US currency has vanished as a result of the PBOC raising foreign yuan funding fees to discourage short sellers. Due to this, hedged purchases of Chinese bonds now offer lower returns than Treasury securities. Therefore, international funds employing such a strategy can instead focus on other bond markets. The predicament highlights how Beijing is finding it more and harder to salvage its faltering currency without incurring costs. Any decrease in bond demand might set China’s efforts to internationalize its currency back and put more strain on the Chinese debt market, which is already under pressure from a widening yield gap with the US. is going to indicate. According to Xu Wang, head of Greater China FX and rates strategy at BNP Paribas SA in Hong Kong, a protracted liquidity shortfall “will limit offshore investors’ interest in onshore bonds and slow down the process of yuan internationalization.” “Restricting offshore yuan funding may only be a short-term fix.”
The calculation suggests that US government bonds would be a better investment for dollar-based investors than yuan notes. Ten-year government bonds issued by China that are currency-defended yield somewhat over 4%, while comparable-maturity Treasuries offer closer to 4.5%. To increase surplus yields, US-based investors used to sell the yuan in the futures market, but this practice has declined as the yuan has lost offshore liquidity. After the PBOC drained liquidity through increased bill issuance and state-owned banks decreased the flow of currency outside, yuan funding costs rose. Since the middle of August, the cost of borrowing yuan in Hong Kong has increased; this week, rates on three-month contracts reached a five-year high. Some bond outflows were previously offset by hedged investor demand, but “even that trade is no longer attractive enough,” according to Stephen Chiu, chief Asia FX and rates analyst at Bloomberg Intelligence. “With so many options available worldwide, there is really no good reason for global investors to hold China bonds.” All of this occurs at a bad time for Chinese banknotes. In August, withdrawals from the nation’s bond market picked up speed as foreign institutional investors reduced their holdings. Bloomberg calculations show that foreign ownership of Chinese government bonds dropped below 8% last month for the first time in four years.
Near-term improvements are unlikely because rising US interest rates will continue to make the Chinese currency less attractive and force the PBOC to maintain high yuan funding costs. The onshore yuan has partially rebounded recently as a result of officials strengthening the currency’s defenses, although earlier this month it hit a 16-year low. At a news conference earlier this week, a PBOC representative stated that China would firmly crack down on actions that disturb the market’s order and avert the possibility of an excessive yuan adjustment. The tough outcome of the FOMC presents a challenge for the PBOC’s foreign exchange policy, according to Wang of BNP. will need to remain engaged for a longer duration.
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