Don't fear the Fed, trust in Tokyo
Even with tapering, opportunities abound in China and Japan, says Jonathan Rogers.
IF YOU SIT in Asia, guessing the big themes for the credit markets in 2014 doesn’t require too much brain power. We can expect more of the same for the offshore bond market, with a rumoured US$15bn of issuance lined up for January and another blockbuster year on the cards – unless, of course, the US Federal Reserve’s tapering proves to be messier an undertaking than the talking heads would have us believe.
Stanley Fischer, the ex-governor of the Central Bank of Israel and favourite to become Fed vice chair – a powerful double act with Janet Yellen, calling to mind a pair of Vaudeville hoofers – recently suggested that he didn’t understand the summer emerging-market meltdown on the back of tapering fears, and proclaimed that EM would be more resilient when the event itself occurred.
So if he’s right, and unless there’s a sharp drying up of offshore dollar liquidity as tapering commences, another record-breaking Asia G3 year, with a baseline starting point of US$150bn in issuance looks a fair guess.
In 2014 the renminbi will take centre stage as it heaves to break free of the shackles of a closed capital account and achieve its natural status as a fully internationalised currency.
I have written before about the Chinese authorities’ desire to rein in offshore issuance guaranteed by standby letters of credit in a bid to slow down overall credit growth in the country’s banking system. The belief that these structures are about to be crimped boosted demand for the recent raft of SBLC issuance last week, but the real story is their use in shifting large amounts of the Chinese unit offshore.
The Bank of Japan is now pumping money into Japan’s financial system at an unprecedented rate
MORE SIGNS THAT authorities are allowing widespread sidestepping of the regulations for offshore remittance are only adding to the belief that the renminbi will soon become a fully transferable currency.
Further signs have come in the form of two intriguing structured deals put together by Standard Chartered, for Hebei Iron and Steel and Sany Group. Conceived off the back of the arbitrage between the US dollar and the renminbi, the format potentially opens the door for a wave of similarly structured transactions. Hebei’s three-year renminbi bonds were backed by a floating US dollar loan made by StanChart and guaranteed by PRC export credit agency Sinosure.
By contrast, Sany issued a US dollar FRN that was backed by renminbi loans guaranteed by the Export-Import Bank of China. StanChart apparently picked up attractive fees for arranging the swaps on the trades and there is no doubt that many more banks with loan book exposure to PRC entities will be looking to exploit a similar opportunity.
Both trades were at three years, underlining the perennial complaint of investors that the offshore renminbi market is unable to offer tenor. But it might just be that China’s commitment to a market-based pricing mechanism that was voiced at the recent communist party plenum will bear fruit much sooner than anyone imagined.
Last week, the first negotiable certificates of deposit were issued by PRC banks, with US$5.6bn-equivalent printing over five days. And this paper was referenced to the Shanghai Interbank Offered Rate (Shibor) rather than at rates set by the People’s Bank of China. This market looks set to balloon in 2014, lifting the use of interest rate swaps referenced to Shibor. It’s not a big stretch from there to the kind of long-dated rates contracts that are needed to support the growth of longer-tenor deals in the burgeoning offshore renminbi debt market.
AS FOR GUESSING the big themes for next year, I reckon in 2014 the yen carry trade will emerge as the big arbitrage opportunity in the face of creeping US rate rises and the massive swell in the Japanese monetary base. Speculative yen short positions in December were as high as in 2007, the final year of what had been a seven-year run of investors borrowing cheap in yen and reaping the carry from higher yielding currency markets plus currency gains from the yen’s depreciation. Yen carry trade data is notoriously difficult to obtain, but you would have to wonder whether the sharp reversals in the burnt-out Indian rupee and Brazilian real markets in the autumn were the results of Japanese-funded buying in action.
Returning to Mr Fischer’s sanguine take on the impact on EM of Fed tapering, it might just be that the yen carry trade is likely to be a decisive “put” in the uncharted waters we will enter in 2014 when the Fed takes its foot off the gas pedal. The Bank of Japan is now pumping money into Japan’s financial system at an unprecedented rate and the yen is depreciating against a raft of higher-yielding currencies. Those who are able to borrow in the Japanese unit in size are likely to pick up the slack in any debt markets that take a tumble as the Fed exits. That will mean that the global liquidity driven EM debt bull market of the past five years has another engine to run on for a while.