Yuan only one factor in rates
Yuan only one factor in rates
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Yuan only one factor in rates
- Kathleen Pender
Sunday, July 24, 2005
Will China's move to loosen its currency's link to the dollar be the pin that pricks the U.S. bond bubble -- and perhaps the housing bubble along with it?
That depends on whether you think China's announcement on Thursday that it would no longer maintain a fixed exchange rate between its currency -- called the yuan, or renminbi -- and the dollar was a symbolic gesture or the start of something big.
On Thursday, the markets were convinced China was taking a big first step toward a free-floating currency, which would require it to buy fewer U.S. Treasuries. That would probably lead to higher U.S. interest rates. In anticipation of such a trend, the yield on the 10-year Treasury bond leaped 0. 12 percentage point to 4.28 percent.
On Friday, investor sentiment shifted. Rather than a major shift in policy, traders decided the revaluation was probably a political move designed to head off protectionist sentiment in Congress and make Chinese President Hu Jintao's visit to Washington in September more pleasant. The yield on the 10- year Treasury bond lost half of Thursday's climb, falling to 4.22 percent.
The reality: Chinese intervention in the currency markets is only one of many factors that affect U.S. interest rates. In isolation, China's decision probably would lead to higher rates. How high would depend on how quickly it moves toward a free-floating currency and whether other Asian countries let their currencies appreciate along with the yuan.
"The Chinese are going to tie the yuan a little bit less to the dollar," says Jim Grant, editor of Grant's Interest Rate Observer. "They will be acquiring fewer dollars with which to manipulate or control their exchange rates. They will be investing less in U.S. Treasuries. All things being the same, and they never are, this could be a bad thing for U.S. bond prices and could tend to push interest rates higher."
China had maintained the dollar peg for 11 years. To do so, it had to buy or sell U.S. Treasury securities to offset changes in market supply and demand.
In recent years, America's growing appetite for cheap Chinese-made goods created a huge demand for yuan. To prevent the yuan from rising against the dollar, China bought large amounts of U.S. Treasury securities.
At the end of May, Chinese investors (including the government and private entities) owned $234 billion in U.S. Treasuries, up from $165.8 billion in May 2004 and a measly $81.3 million in May 2002.
China's Treasury purchases have helped keep a lid on U.S. interest rates. Low rates have encouraged Americans to borrow money to buy even more Chinese electronics, appliances, textiles and other goods.
If the yuan had been freely floating, this trade imbalance would have raised the value of the yuan relative to the dollar. That would have made Chinese imports more expensive and cooled Americans' ardor for them.
Pegging its currency to the dollar gave China an advantage over Asian countries that have more freely floating currencies.
The growing U.S. trade deficit with Japan, for example, has caused the yen to appreciate against the dollar (although that changed course this year).
Although Japan does not maintain a fixed exchange rate, it has been buying Treasuries to compete against the Chinese and hold down the value of the yen.
In May, Japanese investors held $685.7 billion in U.S. Treasuries, more than 2.5 times as much as China, which is the second-largest foreign holder of Treasuries.
"Japan is China's big competitor. Now that the Chinese have revalued the yuan, it gives the Japanese some breathing room," says Jim Bianco, president of Bianco research. Japan's Treasury purchases "won't go to zero, but the growth rate will go down."
Other Asian countries are likely to follow suit. After China's announcement, Malaysia said it, too, would no longer peg its currency, the ringgit, to the U.S. dollar. If every Asian country slows its Treasury purchases by a little, the effect could begin to add up.
Bianco says China gave out too little information to predict exactly how its move will affect the dollar and U.S. interest rates.
In a statement laced with oxymora, the People's Bank of China said it hopes to improve "the socialist market economic system" in China by moving toward a "managed floating exchange rate regime."
It will tie the yuan to an undisclosed basket of currencies. Each day it will announce the closing price of the yuan against various currencies, including the dollar.
It set the starting rate for the U.S. currency at 8.11 yuan per dollar, 2. 1 percent higher than its previous, long-standing rate. That's a small move, considering some U.S. manufacturers say the yuan is undervalued by 30 to 40 percent.
Each day, the dollar can float 0.3 percentage points higher or lower than the previous day's closing price. However, it appears that at the end of the day, the Chinese central bank can set the closing price wherever it wants, says Andrew Foster, director of research with Matthews International Capital Management.
"It's like keeping a bird on a string. The bird can fly wherever it wants on the string. The person holding the string can walk wherever they want. You may walk to where the bird landed and start from there or walk somewhere else, " says Foster.
"By keeping the basket of currencies a mystery, they have the flexibility to outline a central parity rate that may not be where the market put it the previous day," he says.
Foster called China's move "an irreversible step forward toward the eventual convertibility of the currency. Having a truly market-driven exchange rate is some time off. But the train has left the station."
Others see it as politically motivated. To protect U.S. manufacturers against inexpensive imports, certain members of Congress wanted to slap stiff tariffs on Chinese goods unless Beijing let the yuan rise.
"It was much more of political move," says Jim Cusser, a fixed-income manager with Waddell & Reed. "All the politicians were patting themselves on the back, acting like this was the Berlin Wall coming down. It's just not so. It's such an extremely small move."
No matter what happens with the yuan, Cusser says, foreign buyers will continue to scoop up Treasuries because they are generally safer and higher yielding than other countries' debt.
Ten-year U.S. Treasuries are yielding about one percentage point more than comparable bonds from France, Germany, Spain and Holland, and about three percentage points more than Japanese debt, he says. And at a time when other central banks are cutting rates, the Federal Reserve plans to take rates higher.
"We have the most transparent markets in the world," Cusser says. "If I had extra savings and I was a global investor, it's hard to pass up the depth and breadth of the U.S. markets."
Mark Kiesel, an executive vice president with Pimco, says China and Japan have little incentive to let their currencies rise because it would hurt their export sectors.
One reason China might want a more flexible exchange rate policy is to be able to fight inflation if it becomes a problem in its roaring economy. Chinese output grew at a 9.5 percent rate in the first half of this year. But, so far, inflation has been low in China, thanks to strong productivity growth.
Even if China and Japan did let their currencies rise, U.S. interest rates would not necessarily rise because our economy is still soft, Kiesel says. And if the Fed continues raising short-term rates, it will further weaken the economy.
He says Americans have become so mired in debt that even a small rise in long-term rates could slow the economy dramatically.
"Consumers are getting much more fragile in terms of their ability to spend," he says.
"If China revalued (its currency) and U.S. inflation was picking up and the economy was booming, we would have a different view," Kiesel says.
Edmund Harriss, manager of the Guinness Atkinson China and Hong Kong fund, was in Shanghai last week. He says the yuan move was bigger news in the United States than it was in China.
"I belive this is a precursor to further currency moves," he says, but China will be reluctant to move quickly, in part because Chinese companies don't have the hedging instruments that companies in more-developed countries have to protect themselves from currency swings.
"Within two years, I would expect to see the yuan about 10 percent higher, " Harriss says. "But it's not a clear path on how fast it's going to get there.
Net Worth runs Tuesdays, Thursdays and Sundays. E-mail Kathleen Pender at kpender@sfchronicle.com.
Page E - 1
URL: http://sfgate.com/cgi-bin/article.cgi?file=/c/a/2005/07/24/BUGVBDSILT1.DTL
www.sfgate.com Return to regular view
--------------------------------------------------------------------------------
Yuan only one factor in rates
- Kathleen Pender
Sunday, July 24, 2005
Will China's move to loosen its currency's link to the dollar be the pin that pricks the U.S. bond bubble -- and perhaps the housing bubble along with it?
That depends on whether you think China's announcement on Thursday that it would no longer maintain a fixed exchange rate between its currency -- called the yuan, or renminbi -- and the dollar was a symbolic gesture or the start of something big.
On Thursday, the markets were convinced China was taking a big first step toward a free-floating currency, which would require it to buy fewer U.S. Treasuries. That would probably lead to higher U.S. interest rates. In anticipation of such a trend, the yield on the 10-year Treasury bond leaped 0. 12 percentage point to 4.28 percent.
On Friday, investor sentiment shifted. Rather than a major shift in policy, traders decided the revaluation was probably a political move designed to head off protectionist sentiment in Congress and make Chinese President Hu Jintao's visit to Washington in September more pleasant. The yield on the 10- year Treasury bond lost half of Thursday's climb, falling to 4.22 percent.
The reality: Chinese intervention in the currency markets is only one of many factors that affect U.S. interest rates. In isolation, China's decision probably would lead to higher rates. How high would depend on how quickly it moves toward a free-floating currency and whether other Asian countries let their currencies appreciate along with the yuan.
"The Chinese are going to tie the yuan a little bit less to the dollar," says Jim Grant, editor of Grant's Interest Rate Observer. "They will be acquiring fewer dollars with which to manipulate or control their exchange rates. They will be investing less in U.S. Treasuries. All things being the same, and they never are, this could be a bad thing for U.S. bond prices and could tend to push interest rates higher."
China had maintained the dollar peg for 11 years. To do so, it had to buy or sell U.S. Treasury securities to offset changes in market supply and demand.
In recent years, America's growing appetite for cheap Chinese-made goods created a huge demand for yuan. To prevent the yuan from rising against the dollar, China bought large amounts of U.S. Treasury securities.
At the end of May, Chinese investors (including the government and private entities) owned $234 billion in U.S. Treasuries, up from $165.8 billion in May 2004 and a measly $81.3 million in May 2002.
China's Treasury purchases have helped keep a lid on U.S. interest rates. Low rates have encouraged Americans to borrow money to buy even more Chinese electronics, appliances, textiles and other goods.
If the yuan had been freely floating, this trade imbalance would have raised the value of the yuan relative to the dollar. That would have made Chinese imports more expensive and cooled Americans' ardor for them.
Pegging its currency to the dollar gave China an advantage over Asian countries that have more freely floating currencies.
The growing U.S. trade deficit with Japan, for example, has caused the yen to appreciate against the dollar (although that changed course this year).
Although Japan does not maintain a fixed exchange rate, it has been buying Treasuries to compete against the Chinese and hold down the value of the yen.
In May, Japanese investors held $685.7 billion in U.S. Treasuries, more than 2.5 times as much as China, which is the second-largest foreign holder of Treasuries.
"Japan is China's big competitor. Now that the Chinese have revalued the yuan, it gives the Japanese some breathing room," says Jim Bianco, president of Bianco research. Japan's Treasury purchases "won't go to zero, but the growth rate will go down."
Other Asian countries are likely to follow suit. After China's announcement, Malaysia said it, too, would no longer peg its currency, the ringgit, to the U.S. dollar. If every Asian country slows its Treasury purchases by a little, the effect could begin to add up.
Bianco says China gave out too little information to predict exactly how its move will affect the dollar and U.S. interest rates.
In a statement laced with oxymora, the People's Bank of China said it hopes to improve "the socialist market economic system" in China by moving toward a "managed floating exchange rate regime."
It will tie the yuan to an undisclosed basket of currencies. Each day it will announce the closing price of the yuan against various currencies, including the dollar.
It set the starting rate for the U.S. currency at 8.11 yuan per dollar, 2. 1 percent higher than its previous, long-standing rate. That's a small move, considering some U.S. manufacturers say the yuan is undervalued by 30 to 40 percent.
Each day, the dollar can float 0.3 percentage points higher or lower than the previous day's closing price. However, it appears that at the end of the day, the Chinese central bank can set the closing price wherever it wants, says Andrew Foster, director of research with Matthews International Capital Management.
"It's like keeping a bird on a string. The bird can fly wherever it wants on the string. The person holding the string can walk wherever they want. You may walk to where the bird landed and start from there or walk somewhere else, " says Foster.
"By keeping the basket of currencies a mystery, they have the flexibility to outline a central parity rate that may not be where the market put it the previous day," he says.
Foster called China's move "an irreversible step forward toward the eventual convertibility of the currency. Having a truly market-driven exchange rate is some time off. But the train has left the station."
Others see it as politically motivated. To protect U.S. manufacturers against inexpensive imports, certain members of Congress wanted to slap stiff tariffs on Chinese goods unless Beijing let the yuan rise.
"It was much more of political move," says Jim Cusser, a fixed-income manager with Waddell & Reed. "All the politicians were patting themselves on the back, acting like this was the Berlin Wall coming down. It's just not so. It's such an extremely small move."
No matter what happens with the yuan, Cusser says, foreign buyers will continue to scoop up Treasuries because they are generally safer and higher yielding than other countries' debt.
Ten-year U.S. Treasuries are yielding about one percentage point more than comparable bonds from France, Germany, Spain and Holland, and about three percentage points more than Japanese debt, he says. And at a time when other central banks are cutting rates, the Federal Reserve plans to take rates higher.
"We have the most transparent markets in the world," Cusser says. "If I had extra savings and I was a global investor, it's hard to pass up the depth and breadth of the U.S. markets."
Mark Kiesel, an executive vice president with Pimco, says China and Japan have little incentive to let their currencies rise because it would hurt their export sectors.
One reason China might want a more flexible exchange rate policy is to be able to fight inflation if it becomes a problem in its roaring economy. Chinese output grew at a 9.5 percent rate in the first half of this year. But, so far, inflation has been low in China, thanks to strong productivity growth.
Even if China and Japan did let their currencies rise, U.S. interest rates would not necessarily rise because our economy is still soft, Kiesel says. And if the Fed continues raising short-term rates, it will further weaken the economy.
He says Americans have become so mired in debt that even a small rise in long-term rates could slow the economy dramatically.
"Consumers are getting much more fragile in terms of their ability to spend," he says.
"If China revalued (its currency) and U.S. inflation was picking up and the economy was booming, we would have a different view," Kiesel says.
Edmund Harriss, manager of the Guinness Atkinson China and Hong Kong fund, was in Shanghai last week. He says the yuan move was bigger news in the United States than it was in China.
"I belive this is a precursor to further currency moves," he says, but China will be reluctant to move quickly, in part because Chinese companies don't have the hedging instruments that companies in more-developed countries have to protect themselves from currency swings.
"Within two years, I would expect to see the yuan about 10 percent higher, " Harriss says. "But it's not a clear path on how fast it's going to get there.
Net Worth runs Tuesdays, Thursdays and Sundays. E-mail Kathleen Pender at kpender@sfchronicle.com.
Page E - 1
URL: http://sfgate.com/cgi-bin/article.cgi?file=/c/a/2005/07/24/BUGVBDSILT1.DTL
posted by Eastlaw at Monday, July 25, 2005
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