Mordy: DSUM Bucks Bond Trend

November 19, 2013

Companies that can reliably issue bonds for capital spending and working capital will more likely transact trade in RMB. Central banks can also either invest or raise funds in RMB, allowing them to manage their balance of payment accounts.

At this stage, the dim sum bond market is still nascent and small—totaling only about $80 billion. However, its success and stability is of enormous importance to China’s strategy of globalizing its currency.

Case For The Renminbi

With little fanfare, China’s currency has appreciated steadily since it started to float in 2005. Since then, the RMB has never had a losing year versus the dollar.

To understand whether this will continue, one must examine China compared with other global currencies. The value of fiat money, after all, is currently a relative beauty contest, and underlying currency drivers extend far beyond national borders.

Viewed in this context, the bar has never been lower for RMB appreciation. Consider that experimental—even reckless—monetary policy has become de rigueur for central banks. Policy mandates have been enlarged and an ostensible liberation from traditional institutional shackles has been granted.

This is most evident in the West’s leading central banks. Messrs. Bernanke, Draghi and Kuroda are deliberately setting out to seed a small inflation. The risk is that they overplant.

China also knows this. Therefore, its push to expedite RMB internationalization comes with a tacit recognition that currency strength will likely follow. However, the alternative is a continuing dependence on USD funding and trade settlement, and, consequently, unnecessary economic volatility.

The above scenario has historical precedent. In the early 1970s, America was following a path of rampant currency debasement and monetary recklessness. Inflation-phobic Germany recognized this and successfully internationalized the deutsche mark.

This development served Europe well, as it became less dependent on U.S. liquidity; reduced its macroeconomic volatility; and attracted global asset allocators to the German bund.

To make this work, Germany needed to support a sound monetary policy and strong currency. China must do the same.³

DSUM For Defense

It’s been a sharp and—some would say—well-deserved bear market in fixed income this year. Pundits have been falling over themselves to recommend zero bond exposure in portfolios.

We understand this revulsion. After all, who wants to lend to indebted governments determined to depreciate their currency?

Still, there are hazards that accompany this recommendation. Bonds have always been an anchor to portfolios in times of stress. Over the long term, that is unlikely to change.

This is why the Chinese bond market is so encouraging. While almost every global bond market has delivered negative returns this year, dim sum bonds are actually up 4.2 percent year-to-date (as of Q3 2013 and measured by DSUM).

What’s more, these returns have been delivered with higher yields, lower volatility and low correlation (DSUM’s three-year correlation to the iShares Core S&P 500 ETF (IVV | A-99) is 0.31—read: noncorrelated!).


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