China’s foreign exchange reserves rise for second month as yuan expectations stabilise

Rue Irving

China’s foreign exchange reserves rose modestly in December for the second consecutive month as sentiment about the yuan exchange rate remained stable.
China’s foreign exchange reserves, its accumulation of assets valued in foreign currencies, rose by US$11 billion in December to US$3.073 trillion, according to data released on Monday, slightly above median forecast of US$3.072 trillion in a Bloomberg survey.

Many economists view the change in China’s reserves as a gauge of the People’s Bank of China’s (PBOC) intervention in the foreign exchange market to support the yuan exchange rate by selling foreign assets and buying the yuan.

The fact that the reserves remained above the psychologically important US$3 trillion level over the past year suggests that any PBOC intervention remained small over the period, they said.
Capital Economics estimated capital outflows at about US$25 billion last month, showing little change from November.

The yuan depreciated sharply against the US dollar last year up until November, and for the whole of 2018, the yuan was down 5.7 per cent due to worries of the negative impact on the economy from the trade war with the United States.

Foreign exchange reserves fell US$67.24 billion in the whole of 2018, against a gain of US$129.4 billion in 2017.

The yuan’s steep slide against the US dollar for most of 2018 came to an abrupt halt in November, possibly as a prerequisite for a trade deal with the United States before the March 1 deadline, analysts said.China’s central bank to pump US$210 billion into ailing economy

To curb yuan depreciation pressure, the PBOC deployed other currency management tools without having to burn through its foreign exchange reserves, such as capital controls and the use of its “countercyclical factor” in calculating the midpoint of the yuan’s allowed daily trading range.

The central bank also used moral suasion to guide market expectations, and last month, it reiterated its promise that it would keep the yuan “basically stable” at a reasonable and balanced level.
“It is now widely accepted by the market that the yuan will not be allowed to get out of control. This is really quite an achievement for the PBOC and the nation’s foreign exchange reserves are stabilising as a result,” said Nathan Chow, an economist at DBS Bank.

On Monday, the yuan was changing hands at 6.8502 per dollar, unexpectedly rising 0.28 per cent even though the PBOC cut commercial banks’ reserve requirement ratio on Friday.
Recent declines in US Treasury yields and the US dollar, amid signs that the US Federal Reserve may consider a pause in its interest rate increase path, which has provided room for the PBOC to ease monetary policy without creating sharp depreciation pressure on the yuan.

Aidan Yao, senior emerging Asia economist at AXA Investment Managers, expects another three reserve ratio cuts this year to help offset growing economic headwinds.
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Given the outlook for further monetary policy easing this year, China’s onshore bond market is poised for another rise this year, analysts said.
Chinese bonds were the second best performer among nine Asian bonds in 2018, generating an investment return of 1.0 per cent according to JPMorgan. The best performer was the South Korean bond market which returned 1.1 per cent.  “China’s monetary policy easing was the main driver in the onshore bond market in 2018,” said Jason Pang, fixed income portfolio manager at JPMorgan.  “Policy is likely to keep its dovish bias, which is supportive of the onshore bond market. Bonds could potentially rally further in 2019 or at least stay rangebound.”

Moreover, Chinese government bonds continue to be favoured by foreign investors with their upcoming inclusion in major global bond indices starting from April, analysts said.
Foreign investors raised their holdings of Chinese bonds significantly in December, as monetary policy easing by the central bank boosted investment returns.
Overseas funds added 82.7 billion yuan (US$12 billion) in onshore bonds in December – the second largest monthly increase since data became available in 2014 – bringing total foreign holdings at the end of the month to 1.5 trillion yuan (US$218.36 billion), according to the China Central Depository & Clearing Co.
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Te launch of the Bond Connect programme in July 2017 boosted interest in onshore bonds, allowing overseas investors to buy bonds in China using the Hong Kong exchange as a conduit.
As of the end of December, 36 of the top 100 global asset managers were taking part in the programme.

Total trading volume on the Bond Connect programme stood at 71.3 billion yuan (US$10.38 billion) in December, with average daily turnover 3.57 billion yuan.
The Bloomberg-Barclays Global Aggregate Bond Index is expected to include Chinese bonds starting in April, while the inclusion of onshore bonds in the JPMorgan Government Bond-Emerging Market Index and the FTSE Russell World Government Bond Index is expected to take place in 2020.

Becky Liu, China head of macro strategy at Standard Chartered Bank, estimated that full inclusion in all three indices would bring in a total US$286 billion in passive inflows as investors balance their portfolios to include Chinese bonds.  In 2018, Chinese government bond yields with tenors or time-to-maturity between one and 10 years slid more than a full percentage point. Bond prices move inversely to interest rates.  Analysts predict the 10-year government bond yield will decline to below 3 per cent this year from current levels of about 3.3 per cent.