But risk and return tell only part of the story. The Chinese yuan has had only modest correlation to the S&P 500 Index and the Barclays U.S. Aggregate Bond Index (0.11 and 0.06, respectively) over the last five years. Given the uncertainty related to shifts in Federal Reserve (Fed) policy, a non-correlated asset could add valuable diversification to investor portfolios.3
What’s Driving the Yuan’s Performance?
Interestingly, as China has continued down the path of currency internationalization, the increasing means of access have created new opportunities for income in Chinese yuan-denominated assets. So far in 2013, more than one-third of the J.P. Morgan ELMI+ China Index’s performance has been driven by returns from interest rates in Hong Kong and China.4 The remaining performance can be attributed to a broadly stronger yuan. In our view, we can best explain this phenomenon as part of the Chinese rebalancing that is currently being overseen by Premier Li Keqiang.
Outlook
Chinese policy makers have historically proven to be extremely pragmatic. If the best policy for U.S. investors has been to not “fight the Fed,” we believe this maxim also applies to the Politburo Standing Committee in China. During this most recent period of global rebalancing, the Chinese government will continue to make adjustments that affect the Chinese economy. So far in 2013, it seems that an appreciating yuan has been in China’s best interest. As we stated above, a gradual, low-volatility rebalancing seems to be the most logical course of action. Similar to what investors experienced during the Asian financial crisis in the late ’90s, Chinese policy makers appear reluctant to devalue the yuan in the face of market stress. In fact, since the Chinese yuan was allowed to “float” in 2005, it has yet to depreciate against the U.S. dollar in a calendar year.
Rick Harper is head of fixed income and currency for WisdomTree Asset Management. This post was republished with permission from the WisdomTree blog.
1Source: WisdomTree, Bloomberg; August 23, 2013.
2Source: Bloomberg; 2013.
3Source: Zephyr StyleADVISOR, July 31, 2013.
4Source: J.P. Morgan, July 31, 2013.
