Chinese Yuan no Longer a One-Way Trade

In an effort  to avoid overheating in its credit markets while tempering foreign currency flows, the People’s Bank of China has recently been willing to allow the yuan to decline and the weaker yuan is weighing on some bond ETFs.

For example, the PowerShares Chinese Yuan Dim Sum Bond Portfolio (NYSEArca: DSUM), which offers a 3.35% 30-day SEC yield, has traded slightly lower this year. Dim sum bonds, named after the bit-sized Chinese dish popular in Cantonese restaurants, are Chinese yuan-denominated debt issued by international corporations or entities.

The Market Vectors Renminbi Bond ETF (NYSEArca: CHLC), which has a 2.58% 30-day SEC yield, has traded modestly higher this year. Still, some portfolio managers no longer view the yuan as a sure bet to continue appreciating against the dollar.

“The perception in the market has been that the renminbi could only appreciate in value,” said Market Vectors Portfolio Manager Fran Rodilosso, fixed income portfolio manager for Market Vectors ETFs.” “It looks now as if the Chinese have set out to dispel that belief with the People’s Bank of China likely to allow the currency to trade in a wider band, with more latitude to move to the downside.”

Chinese policymakers and the PBOC have their hands full. On one front, the world’s second-largest economy is tasked with getting investors to feel more sanguine with slowing  growth (expected to be 7.5% this year). On another front, China must discourage hot money flows and excessive credit creation, according to Rodilosso.

He points out “renminbi-denominated equities and debt are indeed used to a steady appreciation, with the currency one of very few to appreciate versus the U.S. dollar in 2013. The prospect of greater currency volatility is something that investors will likely start to consider, and ultimately may lead them to demand more compensation, in the form of yield.”