The Weekly Update

The World Bank looks set to issue the first SDR bond created since 1981 via the China Interbank Bond Market (CIBM) as part of a wider push to promote the SDR as a world reserve currency. The first issue is said to be no longer than three years, ~SDR500m (RMB4.6bn) and is expected before October 1st, depending on market conditions. In a statement, the World Bank Group President Jim Yong Kim commented on the 'landmark development for China’s bond market and for the SDR as an international reserve asset,' adding that the World bank is 'pleased to support China’s growing role in global financial markets.'

Historically, the SDR currency has only been used by the IMF and member states as a reserve asset. Private SDR denominated securities were initially issued back in the mid-70s, with Sweden issuing its first SDR denominated credit in 1981 but the market never really took-off due to investor scepticism. So this announcement is a huge step for China, and as Kim said, the issuance of the 'World Bank SDR bonds in China will support the G-20’s objective of expanding the use of SDRs and help promote the development of China’s domestic capital market.'

We expect further international institutions to seek approval to issue debt denominated in SDR via the CIMB. In fact there has been chatter that China Development Bank is looking to issue anywhere between USD300-800m of SDR bonds. The PBoC Deputy Governor Yi Gang also mentioned that a batch of SDR bonds will be issued on the CIBM before the G-20 Summit next month. He discussed the demand from financial institutions and 'other international institutions' for SDR bonds on the CIMB adding that the central bank will 'continue to develop the infrastructure' of the onshore bond market in preparation for 'further issuance of such bonds and the liquidity of secondary markets.'

In a dollar denominated world, the fortunes of many economies is driven in part by the rise and fall of the US currency. Borrowing in a basket of currencies like the SDR would make the borrowing costs of indebted countries more predictable. Whilst it would not prevent countries borrowing to excess, it would make them less vulnerable to large swings in any one currency.

The Chinese are particularly keen on introducing the SDR to the world, but old habits die hard and so despite the logic of the SDR replacing the US dollar as a world reserve currency, it will take a long time before international investors start to replace the US dollar with alternatives like the SDR. Expect to see plenty more SDR issues in China though.

Last week we had the minutes of the FOMC July meeting, where members of the committee generally agreed that more data was needed before the US should consider raising rates, however the timing of any move remains an issue. There seems to be two trains of thought within the committee though, with some of the members wanting more evidence inflation would rise toward target before a hike, however others were concerned low rates could have a negative impact on financial stability, stating that a prolonged period of very low interest rates might cause investors to misprice risk, leading to the destabilising of financial markets.

James Bullard maintained his call for one hike in the foreseeable future, acknowledging risks might be on the upside, however, he still sees a target rate of 63bps as appropriate until conditions change. In a Q&A session after the meeting he said he was not sure if September or later this year is the best time to hike, preferring to see indications of higher GDP growth before moving on rates. William Dudley, an adviser to Chairwoman Janet Yellen also added 'I think we’re getting closer to the day where we’re going to have to snug up interest rates a little bit. And that’s good news'.

One of the challenges facing governments around the world is that insipid growth has not only come at a time of elevated global debt levels but has also been accompanied by an increase in inequality. For the average consumer wage increases are important drivers of confidence and increased discretionary spending but even in the US real median household income has declined since 2007. In Japan studies suggest inequality appears less pronounced than elsewhere with factors such as growth in executive pay less pronounced than places such as the US. The IMF recently noted that full-time wages in Japan have only increased by 0.3 percent since 1995 so it comes as little surprise the economic recovery has continued to falter.

What is clear from all this is that policy around the world is increasingly going into unchartered territory with little success so far in boosting aggregate demand. The outlook remains uncertain and the hunt for yield continues: high quality bonds from creditors, particularly those offering positive yields, remain one of the more attractive places to be positioned.

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