(Bloomberg) — China’s yield discount to the US has expanded to a fresh record, aggravating the challenge for a central bank that’s already fighting gravity to support the yuan.
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The combination of a relentless rally in China’s government bonds and a selloff in US notes has resulted in an unprecedented 300-basis-point gap between the two countries’ sovereign yields. That’s set to add even more pressure on the yuan by increasing the risk of capital outflows, just as the currency slid toward a record low in offshore trading this week.
The development is yet another sign that policymakers may be forced to allow the yuan to weaken, if they wish to support the fragile economy by loosening monetary policy. Illustrating the dilemma, the People’s Bank of China retained its support of the currency market this week right after letting the yuan slide past a key level on Friday.
On top of the yield gap, the yuan is also suffering from a bleak economic outlook amid a prolonged property crisis, weak consumption and concerns over deflation. President-elect Donald Trump’s tariff threats and decreasing bets for US interest-rate cuts are also pressuring the Chinese currency.
“China’s ongoing deflationary pressures amid soft economic activity and weak credit growth continue to pressure yields lower, while relatively firm economic activity is keeping US yields elevated,” said Mitul Kotecha, head of Asia FX and emerging-market macro strategy at Barclays Bank Plc. “The widening rate gap will be a factor continuing to push dollar-yuan higher.”
The yield on China’s 10-year bonds closed below 1.6% for the first time in history on Monday, according to official data. That helped to widen its discount to the US debt of the same tenor to 303 basis points.
Signs of capital outflows have already emerged. In November, China suffered the biggest fund flight on record from its financial markets.
On Tuesday, the PBOC issued yet another fixing that was significantly stronger than the average forecast in a Bloomberg survey to bolster sentiment. It allowed the currency to slip below 7.3 per dollar on Friday, stoking bets China is open to more depreciation.
The yuan was little changed at 7.3439 in offshore trading and was last at 7.3291 in the domestic market.
“The market is watching closely to see if the PBOC will weaken the fixing as depreciation pressure mounts,” said Lynn Song, chief greater China economist at ING Bank in Hong Kong. “This process will be quite gradual, as it looks like policymakers are still intent on maintaining currency stability.”