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Offshore yuan slumps as Beijing pursues "vigorous" fiscal policy

Offshore yuan slumps as Beijing pursues

The offshore yuan slumped to its lowest level for more than a year on Tuesday after the Chinese government said that it would pursue a more "vigorous" fiscal policy to drive growth amid escalating trade tensions and rising economic headwinds.

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By Charles Bliss 25.07.2018

The offshore yuan slumped to its lowest level for more than a year on Tuesday after the Chinese government said that it would pursue a more “vigorous” fiscal policy to drive growth amid escalating trade tensions and rising economic headwinds.

There are growing concerns that a drawn-out trade war with the US could be troublesome for the economy, sentiments that new calculations by Germany’s Bundesbank supported. The research found that the US may benefit from a slowdown in China’s economy, though the latter’s long-term prospects would remain favorable overall. 

The loosening in monetary conditions suggests that China may pursue a change in its policy direction to support growth. “The government is sending a clear signal that it is preparing to defend growth...Premier Li may be concerned about the negative impact of deleveraging on growth,” a note from ANZ Economists Betty Wang and Raymond Yeung said.

Chinese government bond yields (CN10YT=RR) increased in the wake of this news, ending at 3.562%, an increase of 2.9 basis points. This upturn reverses a long-standing decline in the ten-year treasury bond yield, with Thomson Reuters data showing its loss of 50 basis points since the start of the year.

The spread between the long-term yields and US treasuries narrowed last week, hitting 19-month lows. Investors have been drawing away from the yuan after the US Federal Reserve recently noted its intent to raise rates on at least two more occasions during the calendar year.

Borrowing costs on a global scale saw a significant jump on Tuesday amid growing speculations that the Bank of Japan is on the verge of dialing back monetary stimulus with a raft of new measures.

China’s State Council announced its own reverse on Monday as it outlined plans for a more robust fiscal policy. China's central bank also used its medium-term lending facility (MLF) to deliver 502 billion yuan to financial institutions. This is part of a drive to support lending to strengthen the rate of growth.

The pivot towards fiscal easing follows the central bank’s decision to cut certain reserve requirements and release 700 billion yuan in liquidity earlier this month. Tightening cash conditions and concerns about economic drag owing to the worsening US-China trade dispute encouraged this move.

Economists are not sure whether further reserve requirements are in the offing this year but have not ruled out the possibility entirely. China said that it is not planning any broad monetary loosening for now, but economic data suggested that there were signs of weakness present even before trade tensions escalated. 

Bond market sentiment is currently weak, according to an Asian bank trader in Shanghai. There is no consensus among primary market players on the medium-term outlook for rates. Stocks did rise on Tuesday, which is a welcome relief for Shanghai’s benchmark Composite, as it is still the worst-performing stock index in the world this year. 

The Shanghai Composite and the blue-chip CSI 300 both saw gains of 1.6% on Tuesday. The news was not as good for the yuan, as it continues to show weakness after suffering a record worst month in June. China said on Monday that it has no desire to devalue the yuan following criticism from US President Donald Trump.

 “The market now believes that chances for the yuan to rebound are getting low, unless there would be a strong official guidance from the authorities,” a foreign bank trader in Shanghai said. “Tolerance is higher. Investors thought that the 6.7 per dollar was the floor, then 6.8, now both are gone.”

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