China Update – Tuesday, June 13

China’s Ministry of Finance made two important announcements today. For the first time, China indicated its intentions to reduce the amount of yuan-denominated bonds it offers in Hong Kong. It will issue CNY14 bln of bonds in H2 17. This is the smallest since 2010. It will complement the yuan issue by issuing $2 bln of USD-denominated bonds.  

The changing fortunes of the yuan have seen its deposits in Hong Kong nearly halved from the CNH 1 trillion reached at the end of 2014. Chinese officials have tried to curb outflows and arrest the slide in the yuan, which has fallen for three years. In addition to capital controls, the PBOC is thought to have helped engineer a liquidity squeeze in Hong Kong that makes it expense to be short. According to Bloomberg, the overnight rate in Hong Kong is averaging the highest in at least three years here in 2017. 

The US-dollar issue will be the first in over a decade. Scarcity will likely translate into tight pricing. The five-year dollar note sold in 2004 yielded about 60 bp more than the comparable US issue at the time, according to Bloomberg data. The supply may be calibrated to facilitate the expansion of Chinese banks’ offshore expansion. 

After finishing 206 near 3.05%, the 10-year (generic) yield rose to 3.70% by early May. It has subsequently pulled back. Today at 3.585%, it is the lowest since May 5. It is the fifth consecutive decline and eight of the past 11 sessions. After a firm Q1, the Chinese economy appears to have lost some momentum, and the official deleveraging push appears to moderate. That said, the one-year yield is at 3.63%, keeping the curve inverted.  

The Federal Reserve is widely expected to hike the Fed funds target range tomorrow. The last two times the Fed hiked, the PBOC quickly followed with a 10 bp increase in the reverse repo rate. While investors will scrutinize the PBOC’s actions tomorrow and a move is possible, it seems unlikely that they repeat the snugging.