Record Yield Premiums Spur Best Yuan Gains in Three Months: China Credit

With the Chinese yuan rising 0.41 percent versus the dollar in the last two weeks,  China’s five-year notes and comparable U.S. Treasury issues was at a record high yesterday. The growing strength of the yuan was boosted by strong GDP forecast and rising consumer prices. From Bloomberg News:

The People’s Bank of China raised interest rates three times this year and boosted lenders’ reserve-requirement ratios on six occasions, exacerbating a cash crunch that’s driving bond yields higher and making local assets more attractive to overseas investors. U.S. Treasury yields are falling amid signs the economic recovery is losing momentum. Gross domestic product rose 1.6 percent in the second quarter, compared with growth of 9.5 percent in China, official data show.

“U.S. Treasury yields have eased on growth concerns, while China remains characterized by a strong GDP outlook, still high inflation and a relatively tight monetary stance,” said Delphine Arrighi, a Hong Kong-based rates strategist at Standard Chartered Plc. “It is an incentive to bring funds into China, which is why the central bank monitors this very closely.”

Despite the rising value of the yuan, an advisor to China’s central bank remarked that the yuan will not be a major reserve currency in the next decade. From Reuters:

Confidence in the dollar and the U.S. economy has taken a beating after the United States narrowly escaped a disastrous debt default this week, running the risk of losing its gold-plated credit rating.

Xia’s prediction for the yuan’s future contrasts with others in China who, worried about the dollar’s prospects, have called for alternative reserve currencies, including the yuan.

Xia did not elaborate on why he thought the yuan would not grow into a major reserve currency, but made clear that Beijing should stick to its present model of a managed floating currency regime to shield its economy from risks.

Without giving details, he said China should not have a free float currency regime in the next 10 years, and that while its capital account must be freed to make the yuan convertible, capital controls should only be loosened gradually.

Dagong Global Credit Rating Company, a Chinese agency, downgraded the United States from A+ to A, signifying growing concerns over Washington’s long-term ability to repay its debts. From CNN:

“The squabbling between the two political parties on raising the U.S. debt ceiling reflected an irreversible trend on the United States’ declining ability to repay its debts,” Dagong Chairman Guan Jianzhong told CNN.

“The two parties acted in a very irresponsible way and their actions greatly exposed the negative impact of the U.S. political system on its economic fundamentals,” he said.

Ironically, Dagong’s move could hurt not just the United States but also China, the largest foreign owner of U.S. debt with holdings worth almost $1.2 trillion.

“Our downgrade simply reflects reality,” Guan said. “Our rating didn’t cause China to lose any money — it was the inappropriately high ratings for the U.S. by Western agencies that had led China to make risky investments in U.S. debt.”