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Strategies & Market Trends : Technical analysis for shorts & longs -- Ignore unavailable to you. Want to Upgrade?

To: Johnny Canuck who wrote (42562)	7/23/2005 4:15:49 PM
From: Johnny Canuck	Respond to of 70039

Yuan move may push up rates Bond market undecided about impact Financing U.S. deficits considered key STEVEN THEOBALD BUSINESS REPORTER China's decision to start letting its currency appreciate could translate into higher borrowing costs, including longer-term mortgage rates, some economists are warning. China has been a key buyer of American government bonds, known as Treasuries, holding an estimated $250 billion (U.S.) worth, issued to finance the ballooning American trade and government deficits. That voracious appetite for U.S. Treasuries could start waning as China moves its yuan away from a direct peg to the U.S. dollar in favour of a basket of currencies. In fact, China's decision may very well trigger a shift by all of the major Asian central banks out of U.S. dollar reserves, which had acted to subsidize U.S. interest rates by keeping bond yields artificially low, Stephen Roach, chief economist at Morgan Stanley, said in a report released yesterday. "Unfortunately, that's probably the only way for the U.S. and the rest of the world to come to grips with its most glaring excesses." China's surprise decision on Thursday prompted Malaysia, too, to announce it will switch its ringgit from a direct peg with the greenback to a managed basket of currencies. "Other central banks, such as the Bank of Korea, have been itching to diversify out of dollars," Roach said. It's far from certain that Asia will start shunning U.S. bonds, though it is a risk, said Doug Porter, deputy chief economist at BMO Nesbitt Burns. "Let's put it this way: It is unlikely they will end up buying more Treasuries." Such concerns were behind Thursday's bond-market selloff, in which 10-year yields climbed 0.10 percentage points in the U.S. and 0.04 percentage points in Canada, Porter noted. Both gave up some of those increases yesterday. The rejigging of the yuan will exert upward pressure on longer-term U.S. interest rates, pulling Canada along to a lesser extent, Porter said. "We can never divorce ourselves entirely from U.S. rates." That said, Canadian bond yields have shown increased independence, with 10-year yields falling nearly half a percentage point compared with those in the U.S., Porter added. Canadian interest rates are expected to start rising after the Bank of Canada suggested it will begin increasing its benchmark overnight rate, with many analysts expecting the first move on Sept. 7, the next policy-setting date. The overnight rate directly influences short-term rates such as a commercial bank's prime lending rate and variable-rate mortgages. Market-driven bond yields largely determine longer-term mortgage rates. So far, higher U.S. short-term rates have failed to push up longer-term rates, confounding even U.S. Federal Reserve Board chairman Alan Greenspan. Despite the U.S. government's need to finance its massive current-account deficit as well as inflation threats, investors have not demanded richer bond returns. Greenspan has hiked the Fed's trend-setting funds rate for nine consecutive policy meetings, taking it to 3.25 per cent last month in an attempt to keep inflation under control. Looking ahead, a stronger yuan means Chinese imports will cost more, putting further pressure on U.S. — and indeed global — inflation rates. In turn, that puts even more pressure on the Fed to continue raising U.S. short-term interest rates. The bond market didn't waste time jumping to the wrong conclusions regarding the impact of revaluing the yuan, suggested Avery Shenfeld, senior economist at CIBC World Markets. For starters, the People's Bank of China statement was decidedly murky, he wrote in a commentary emailed to clients. "Its announcement was deliberately crafted to let a thousand flowers bloom in varying interpretations." Even if the yuan is allowed to appreciate 10 per cent against the greenback over the next year, the massive Chinese trade surplus assures a continued flow of capital into U.S. bonds, Shenfeld said. Besides, the alternatives are not attractive. "Let's not forget about the rest of the world. Interest rates in Japan are still near zero, and in Europe, overnight rates are stuck at 2 per cent."