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Revaluing the Chinese Yuan could have significant ramifications for the global bond markets. China currently holds over $191 billion in US Treasuries, second only to Japan. Given the current state of affairs, the Chinese Yuan (CNY) is considered to be significantly undervalued against the US dollar. In order to maintain the peg in a tightly controlled environment, the People's Bank of China is actively intervening in the currency markets selling Yuan, buying US dollars and in turn using those dollars to buy US Treasury securities. If the peg is lifted or adjusted and the Yuan appreciates against the dollar, China will have less of a need to purchase US treasuries and may even consider reducing their exposure. The size of the impact on the bond markets will depend upon how much China widens the trading band of the Yuan or whether they decide to peg their currency to a basket of currencies. Either way, it could result in a reduced need for US treasuries and increased need for European and Japanese government bonds.
China's selling of treasuries will drive prices down; lift the yields and increase borrowing costs for the US Government, which uses the bond market to finance its deficits. Since most of the corporate bonds are priced based on the spread between the Treasuries and various credit (default risk) spreads, it will also increase the cost of capital for many corporations. If the cost of capital goes up, this could have residual impact on broader components of the economy. These corporations would have to compensate for the increase in costs by instituting layoffs or decreasing capital expenditures. The impact of these adjustments will be first felt in Asian equity markets, as slowdown in the regional economy will translate into lower growth and decline in |
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corporate earnings. As corporate earnings decline, so will the companies stock prices and the "domino effect" may take place as stock prices will begin to decline globally. Another issue to consider is emerging market bonds where various countries with poor credit ratings come to borrow money.
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Any increase in the Treasury yields will be instantly felt by developing countries, which will have to pay a higher interest to attract investors, and in turn the probability of default increases with the increase in interest burden. Such defaults may become more frequent thus putting more pressure on emerging and developing countries to pay higher interest to attract investors. |
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