Wealthy Nations Daily Update - China

“Let China sleep. For when she wakes, she will shake the world,” Napoleon Bonaparte apparently said. Well first thing this morning two of every five news items on the screens related to China and the impact a weakening economy will have on world growth and currency values. Indeed the People’s Bank of China (PBoC) has been aggressively intervening in the offshore currency, to crack down on speculators it is reported, and has fixed the onshore currency in a tight range for the third day running.

Bets against the yuan will fail and calls for a large decline are “ridiculous,” said Han Jun, the deputy director of China’s office of the central leading group for financial and economic affairs.

For the Wealthy Nations Bond Fund, the renminbi class is hedged using Non-Deliverable-Forwards (NDF) which is based on CNY, the onshore restricted currency. Renminbi in deliverable form is called CNH, which trades offshore and currently trades at a significant discount to the onshore rate. Ultimately, we believe that the PBoC will want to see CNY and CNH converge possibly to merge into one currency unit.

This morning CNY is trading at 6.5601 compared to 6.5857 for CNH. The mechanism for the PBoC to narrow this gap is to drain liquidity in CNH which will cause interest rates to rise and force speculators to close their shorts. This morning the overnight CNH rate jumped to 66.82% which has caused a short covering rally in CNH, a jump of approximately 1.25% was seen. With this move the PBoC has also announced that “stability against the basket will be enhanced” although noting that there is not a “tight peg to the basket” which implies a band within which the currency will be allowed to fluctuate. We speculate the band remains at 2%.

It is worth noting that the one month rate is currently trading at a 1.25% discount which means that investors will be receiving an annualised rate of 15% per annum for holding the renminbi, although we would not expect these levels to persist for long.