Last week marked the one year anniversary of the People’s Bank of China’s (PBoC) announcement of its reform to the onshore renminbi (RMB) fixing mechanism; which saw a large “one-off” devaluation of the currency. This created a huge amount of panic market wide, with some interpreting the change in exchange policy as being one aimed at gaining export competitiveness. We were however of the opinion that the central bank’s motivation was more to do with IMF’s decision on whether to include the currency in its SDR basket; where one of the institution’s criticisms of China’s foreign exchange policy was that the exchange rate was not driven by market forces.
One year on and the renminbi exchange rate policy has come a long way; the PBoC appears to have released its tight grip on the RMB fix, allowing it to be more market orientated and transparent. Developments include the announcement of capital account liberalisation rules (another key change for SDR inclusion), the introduction of the CFETS basket and opening of the Chinese interbank Bond Market (CIBM) to qualified foreign investors, and finally the more “rule-based”, “close+basket” fixing rule.
It is also just over eleven years since China broke the decade long peg to the US dollar letting the currency appreciate from a rate of 8.2 to Friday’s 6.65 level; an appreciation over the period of around 19%, or 1.7% per annum. We remain of the view that the Chinese currency will continue to appreciate over the coming years.
The Bank of England (BoE) last week struggled to buy enough long dated gilts as investors continue to cling on to developed government bonds of all varieties. Following the BoE’s decision to cut the UK base rate and expand its quantitative easing programme by £60bn it only managed to receive offers to purchase £1.12bn of gilts with maturities over 15 years versus their target of £1.17bn. This prevailing shortage, versus demand, of government bonds looks likely to remain a prolonged dilemma for central banks and investors alike.
The natural result of this shortage of usual safe assets is of course for yields to remain low; resulting in some moving into other securities with low expected risk and others to reach for yield further down the credit curve. With $12-13tn of negative yielding debt extending to maturities past 10 years in Germany and 15 years in Japan some have flocked to government bonds from countries such as Spain, which saw its benchmark 10-year yield fall (and remain) below 1% for the first time on record last week. This might seem attractive compared to 0% or less yield - but only if they are indeed an equivalent low risk investment. However such debt reached yields of 7% during the European crisis of 2012 and has high levels of government and overall net foreign debts. We do not believe that this is an appropriate low-risk-low-yield alternative and it offers far too little to compensate for the obvious risks. We would much rather invest within net creditor nations that can afford to pay you back and simultaneously offer yields that are a multiple of what Spain currently offers.