Wider Skepticism Hits Chinese Assets: Yuan and Bonds Expected to Struggle Amid Global Uncertainty

The prevailing gloom surrounding Chinese assets is expanding beyond battered stocks, as investors now anticipate challenges for the yuan and government bonds. The skepticism comes at a time when the Federal Reserve’s dovish pivot is poised to support emerging markets, making China’s economic outlook even more challenging. As bearish sentiment intensifies, the People’s Bank of China (PBOC) faces limited room to lower interest rates compared to its global counterparts, hampering efforts to stimulate economic growth.

Key Points:

1. Bearish Outlook: With recent data confirming China’s economic struggles, skepticism towards Chinese assets has increased. The Federal Reserve’s dovish stance is expected to benefit emerging markets, but China’s economic challenges are hindering confidence. The People’s Bank of China is under pressure to lower interest rates, but its limited room for cuts compared to global peers poses challenges.
2. Yuan Under Pressure: Currency strategists, including Ken Cheung of Mizuho Bank Ltd., expect the yuan to face pressure due to bearish expectations for China’s growth in the coming year. The offshore yuan has already weakened over 1% in the new year, adding to the nearly 3% drop observed in 2023.
3. Bond Market Support: While skepticism grows, bonds are expected to find support as the PBOC maintains an easing bias. However, concerns over renewed yuan depreciation and narrow net interest margins among Chinese banks limit the potential for rate cuts.
4. Global Comparisons: As China falls out of favor, traders express more positivity towards other emerging markets. Higher-yielding markets, such as South Korea and India, are poised to benefit from anticipated rate cuts by the Federal Reserve. Potential inclusion in major global bond indexes for South Korea and India could further boost their assets.
5. Global Market Dynamics: Recent events, including the PBOC’s decision to keep its one-year policy rate unchanged, have disappointed investors. Despite calls for more stimulus, China’s leadership has emphasized achieving economic expansion without massive stimulus, contributing to a new-year selloff in Chinese assets.
6. Yuan’s Relative Weakness: Analysts, including Julio Callegari of JPMorgan Asset Management, see a weakening bias in the yuan basket against trading partners in the first half of the year. Expectations for relative value opportunities and potential declines in the yuan’s basket against trading partners are considered.
7. Comparative Yields: While China’s government bonds have seen positive results so far, higher-yielding markets, such as India, Mexico, and Brazil, are gaining attention. China’s benchmark 10-year yield of around 2.5% is less attractive compared to the yields in these other markets, signaling a shift in investor preferences.
8. Forward Projections: Economists anticipate the yuan will underperform its Asian peers, projecting a 3% fall to 6.99 against the dollar by the end of December. Comparatively, emerging Asia ex-China pairs are projected to have an average 4.4% drop. This follows a third consecutive week of declines for the offshore yuan against the dollar.
9. Investor Strategies: Some investors are opting for local-currency bonds and currencies in countries where policy rates have been preemptively hiked, such as Brazil and Mexico. The dollar’s strength and less attractive yields in China contribute to the perception that the yuan will be uninspiring in the current market environment.

As global uncertainties impact Chinese assets, including the yuan and government bonds, investors are reevaluating their strategies and seeking opportunities in other emerging markets with more favorable outlooks.