Global markets fear US Treasuries sell-off as China ends currency freeze
Global markets are braced for a possible sell-off in US Treasury bonds after China said over the weekend that it will allow the yuan exchange rate to adjust against the dollar, ending a two-year currency freeze that has led to trade clashes with Washington and Brussels.
By Ambrose Evans-Pritchard
China’s Central Bank said the economic recovery had opened the way for a return to “flexibility” but ruled out an immediate one-off rise in the yuan. The currency will be allowed to fluctuate within a widened band of 0.5pc each day against a basket of currencies.
The yuan is now expected to rise slowly against the dollar, although it may fall if the euro weakens further. “There is at present no basis for major fluctuation or change in the exchange rate,” said the bank.
The policy shift is a goodwill gesture towards the US and Europe before next week’s G20 meeting in Canada as a rising yuan helps Western industries compete against Chinese imports. US Treasury Secretary Tim Geithner welcomed the step but said “the test will be how far and how fast they let the currency appreciate.”
Senator Charles Schumer, a leading critic of China on Capitol Hill and author of legislation calling for sanctions, dismissed the announcement as meaningless. “This is China’s typical response to pressure. Until there is more specific information about how quickly it will let its currency appreciate and by how much, we can have no good feeling that the Chinese will start playing by the rules,” he said.
When China allowed the yuan to rise in July 2005 the move triggered a slide in US Treasury bonds, with knock-on effects on US mortgage and corporate debt. Investors will be watching closely to gauge response to sales of $108bn of US notes this week.
China has become the biggest force in global bond markets with holdings of $900bn (£600bn) of US government debt. Yuan revaluation is likely to dampen China’s export growth and slow the pace of reserve accumulation, reducing the need to recycle money into foreign bonds. Hans Redeker of BNP Paribas said a rising yuan may have the effect of draining liquidity from global asset markets.
However, Jim O’Neill of Goldman Sachs said the shift by China was a vote of confidence in recovery and should help rebalance the global system. “It is bullish for risky assets. China has become more optimistic about growth and doesn’t see the eurozone debt crisis having a material effect,” he said.
The country had a trade surplus of $19.5bn in May. Its annual surplus has reached 0.6pc of global GDP, a world record. This is greater than that of Japan in the late 1980s and the US in the late 1920s.
A number of Chinese economists say it is in the country’s interest to let the yuan rise before overheating gets out of hand. Reserves have reached $2.4 trillion, causing inflationary “blow back” into China.
Beijing is determined to avoid Japan’s fate when it let the yen rise too fast, tipping the country into slump. But the policy of holding down the currency is leading to acute price pressures. Factory gate inflation reached 7.1pc last month. Food costs are rising fast, raising the risk of civic unrest among migrant workers.
Rising wages are inflicting similar pain on exporters to a currency rise but with more pernicious effects for the country. As a result, analysts say it no longer makes sense for Beijing to maintain the peg.
Nomura says property has reached frothy levels in Shanghai and Beijing, where prices are 13 to 14 times income. It expects the bubble to pop “very soon”.