© Reuters. FILE PHOTO: Chinese 100-yuan banknotes are seen on the counter of a branch of a commercial bank in Beijing, China, March 30, 2016. (REUTERS/Kim Kyung-hoon/File Photo)
Written by Winnie Zhou, Tom Westbrook, and Brenda Goh
SHANGHAI/SINGAPORE (Reuters) – Bond markets are putting Chinese and global interest rates on opposite tracks, jitters over cuts in China versus increases in the United States and have led Chinese banks and companies to prepare for a weaker currency as Beijing rolls out more stimulus.
The yuan has fallen past the closely watched seven level for the dollar last month and has not stopped, as China’s post-pandemic economic recovery falters amid weak demand at home and abroad.
This week hit a six-month low on the dollar after China’s surprise rate cuts, putting the gap between China’s and US 10-year sovereign bond yields at its widest since November. The gap with British returns is the widest in 16 years.
The situation, with China’s rates lower than those of the United States, is the opposite of more than a decade of high growth that has seen China pay better returns than markets in the West.
Its failure to relax as the pandemic subsides has caught many by surprise – along with the speed of the yuan’s recent slide – investment banks have lowered forecasts for the currency, and analysts see risks ahead as companies hoard dollars.
“(The yuan) is set to remain under pressure from negative structural impediments to supportive flows, including inflows of foreign investment bonds and dollar corporate sales,” JP Morgan analysts said in a note.
“The People’s Bank of China’s tolerance of currency weakness … also opens up room for further yuan weakness.” JP Morgan recently lowered its forecast for the yuan by the end of the year, from 6.85 per dollar to 7.25 per dollar.
The yuan has lost nearly 4% so far this year to 7.1674 against the dollar on Wednesday, making it one of the worst-performing Asian currencies, as China’s post-COVID recovery quickly lost steam.
Some investment banks expect the yuan to end the year weak at 7.3 — a level seen in November when China’s borders closed and strict health policies disrupted economic activity.
This means a further decrease in value of 1.8%.
The People’s Bank of China did not immediately respond to a Reuters request for comment on banks’ downgrades of the yuan outlook or risks to the currency from corporate positions.
risk factor
Policy actions and expectations are driving prices and currency markets in tandem with the expectation that Western economies will continue to struggle to rein in inflation and keep policy settings tight, while China will struggle to replicate its pre-pandemic growth.
Even if the Federal Reserve holds interest rates steady later on Wednesday, as expected, traders are bracing for a prolonged period of higher U.S. interest rates and, increasingly, for China to keep or push rates lower.
China this week lowered the reverse repo rate and another short-term cash rate for commercial banks, seen as a sign that more policy easing is in the offing. Analysts polled by Reuters expect the People’s Bank of China to cut medium-term loan costs on Thursday and many market watchers expect it to cut its benchmark lending rate next week.
The authorities have also directed state-owned banks to lower interest rates on dollar deposits, according to people with direct knowledge of the matter, in a bid to prompt exporters to convert their huge and growing pile of dollars back into yuan.
Chinese companies accumulated $24.2 billion in “excess” dollar savings over the past year, JPMorgan estimates, bringing total foreign exchange deposits in China to $851.8 billion at the end of May.
Carrying some of that over to the yuan should certainly be supportive, and the forwards market suggests that traders are less bearish than the bank had expected.
Tommy Zeh, head of Greater China research at OCBC Bank, said that lowering the interest rate on dollar deposits would be a counter-cyclical measure, and discourage borrowing in yuan to buy dollars.
However, traders and analysts said the companies were unlikely to follow the authorities’ intended path and might channel their capital outside China into offshore accounts.
SOFR, the dollar’s benchmark overnight rate, traded at 5.05% on Wednesday, 75 basis points above the ceiling of dollar deposit rates at major banks in China, showing that the dollar can earn better interest abroad.
“Companies may be increasingly tempted to put their dollar revenues into offshore accounts,” said Kyung Seung, chief Asia macro strategist at Societe Generale (OTC:).
“The outflow of capital was a clear risk factor for further depreciation of the yuan in the second half of this year,” he said, with lower interest rates on dollar deposits posing such a risk.