Trump Spends, Xi Saves, and China's Yuan Rises Again

(Bloomberg Gadfly) -- Just a few months ago, China's big ambition of turning the yuan into a global reserve currency to rival the dollar looked to have been dashed. Beijing's fiscal prudence and a spendthrift Washington are combining to revive the currency's appeal.

In October, the government sold its first sovereign dollar debenture since 2004. Sales of dim sum bonds -- yuan-denominated debt issued outside domestic markets -- had gone into dormancy after China's 2015 devaluation. Meanwhile, the yuan remained a negligible component of  the world's foreign-exchange reserves, making Beijing's campaign to enter the International Monetary Fund's prestigious SDR basket look like little more than a vanity project.

Now, future movements in the dollar and Treasury bonds are so uncertain that companies are embracing the idea of financing in yuan again. Case in point: Dim sum bonds are off to their best start since 2015. Companies have raised more than $5.7 billion, on track for a record year.

It's no secret that the dollar's performance has become divorced from Treasury yields. In theory, higher interest rates can attract portfolio flows and strengthen a currency. Instead, the dollar and bond yields have diverged further this year.

Chinese firms wanting to escape the low-liquidity onshore corporate bond market must reckon with this enigmatic breakdown. They must consult their crystal ball not only for interest-rate risk but also currency risk.

That's a tall order for any corporation. After raising dollar debt twice in 2018, Country Garden Holdings Co. switched this week, selling a three-year, 950 million yuan ($150 million) dim sum bond at 5.8 percent, at the low end of its indicated range. In a space dominated by financials, the developer's issue stood out. 

Dim sum investors are betting the yuan will at least be stable after a 2.76 percent appreciation against the dollar this year, and that yields on Chinese government debt will be less volatile than those of Treasuries.

They may be right. Rapid deterioration in U.S. government finances -- thanks to President Donald Trump's tax cuts -- may well have a more significant impact on the greenback than rising interest rates. The dollar fell substantially after George W. Bush's tax cuts in 2001 and 2003, even though the Federal Reserve raised its benchmark rate at 17 meetings in a row from 2004 to 2006, according to Macquarie Research's Ric Deverell.

Meanwhile, China is exhibiting a lot more macro prudence. At the National People's Congress this week, the government lowered its fiscal deficit target to 2.6 percent of gross domestic product from 3 percent. By contrast, economists expect the U.S. budget deficit to worsen. 

Investors raised eyebrows last week when China proposed to repeal presidential term limits, in a step that would allow Xi Jinping to rule beyond 2023, and perhaps keep the 64-year-old in power for life.

At least Xi is paying attention to the threat of a Minsky Moment and taking steps to curb financial risk. Trump, on the other hand, is still burying his head in the sand.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Shuli Ren is a Bloomberg Gadfly columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

To contact the author of this story: Shuli Ren in Hong Kong at sren38@bloomberg.net.

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