Chinese Yuan Revaluation and Bonds

Chinese Yuan Revaluation and Bonds

For Treasury traders, there’s another currency-related issue that is important to follow and that is the gradual revaluation of the Chinese yuan.

For most of its history, the yuan or renminbi (RMB) was pegged to the U.S. dollar. In the 1980s, the RMB was devalued to promote growth in China’s economy, and between 1997 and 2005 the People’s Bank of China artificially maintained a USD/RMB rate of 8.27.

At the time, it received significant criticism because keeping the peg meant that the Chinese government would artificially weaken its currency to make Chinese goods more competitive.

To maintain the band, the Chinese government had to sell the yuan and buy U.S. dollars each time their currency appreciated above the band’s upper limit.

These dollars were then used to purchase U.S. Treasuries, and this practice turned China into the world’s largest holder of U.S. Treasuries.

In 2005, however, China ended its dollar peg and linked the value of the yuan to a basket of currencies and allowed it to fluctuate within a narrow band that was reset every day.

While the exact percentage of the basket is unknown, it is largely dominated by the U.S. dollar and includes other currencies such as the euro, Japanese yen, South Korean won, British pound, Thai baht, Russian ruble, and Australian, Canadian, and Singapore dollar.

Through the years China has gradually widened the band that the yuan can trade in, but if China were to end the float and allow the RMB to trade freely on the global foreign exchange market, the impact on the fixed-income markets would be significant because it would reduce the government’s need to purchase Treasuries and other fixed-income securities.

An announcement of this sort would send yields soaring and prices tumbling. While it could be years before this happens, it will be important for bond investors to follow these developments if they want to effectively manage the risk.

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