Chinese local interest ratesrose substantially late last year, and many bond offerings have been canceled, creating financial strain for some Chinese companies.How should global investors interpret events in China, and what can they expect for early 2017'Clearly, investors in China are on edge: Over the past few months, the Chinese yuans decline and capital outflows have continued apace, while the Peoples Bank of China (PBOC) has taken steps to tighten financial conditions. Adding to the nerves, a little over a year ago, a rate hike similar to the one last month by the Federal Reserve precipitated a downward spiral in the yuan and steep declines in equity and bond markets around the world.In our view, China is still facing what economists call a trilemma. It is proving impossible to achieve three goals simultaneously: a stable or fixed foreign exchange rate, free capital movement and an independent monetary policy. Combining tighter financial conditions with this policy trilemma means that the currency will probably remain an escape valve.In the short term, capital outflows will likely continue. Despite Chinas ever-tighter restrictions on currency movements, individuals can still convert the equivalent of US$50,000 into foreign currency annuallyand they likely will as the yuan declines further. Over the year, our base case is for the yuan to decline against the U.S. dollar by a mid- to high-single-digit percentage. However, we also think the possibility that the PBOC will allow the yuan to float freely, or at least widen its trading band, has increased.In recent months, the PBOC has shifted its policy focus from promoting growth to reining in the highly leveraged financial sector. As a result, overall liquidity is likely to remain tight and local interest rates are likely to remain elevated at least through early this year.Fundamentally, we think higher rates will have a dampening effect on growth over the coming year; our forecast is for a slide in Chinese GDP growth to 6%6.5% in 2017 from the current 6.7%. More negative headlines, continued stress in the local bond market and disruptive market moves in general will likely feed into the general pressure on growth.Investment implications on ChinaSelling in the local Chinese bond market has so far driven yields significantly higherby about 100 basis points (bps) for government bonds and 200 bps for corporate bondsbut we expect yields to remain both volatile and elevated for some months, and clear buying opportunities may not surface until well into this year.Amid the disruption in Chinas bond market and ongoing capital outflows, the implication for investors is straightforward, in our view. As the Fed raises U.S. interest rates in 2017 (we anticipate two to three increases) and the Chinese yuan continues to decline, we still favor long positions in the U.S. dollar versus the yuan and other emerging Asia currencies.SEE ALSO:Real estate all over the world could tank as China curbs capital outflowJoin the conversation about this storyNOW WATCH: The best way to clear out a ton of space on your iPhone superfast
Click here to read full news..
