BUZZ-COMMENT-Dark clouds over China obscure a bright spot for the yuan

May 25 (Reuters) – Amid China’s self-inflicted economic crisis, yuan bulls are starting to weigh short-term threats with long-term potential. Increasingly gloomy growth forecasts nL3N2XG257nL2N2XB071 are blotting out one bright spot that has appeared in the bond market.

The yield gap between the 10-year U.S. Treasury note and China’s equivalent government bond is reversing in favour of the latter. If U.S. inflation is indeed peaking nL2N2XG1R3, yuan-denominated bond outflows might finally subside nL3N2XF1MK nL2N2XA040. U.S. core inflation data due Thursday will provide fresh insight for bond traders.

On the other side of the equation, China’s central bank still appears hesitant to cut benchmark interest rates, which should assuage fears of declining yields for fixed-income investors. Last week’s bigger-than-expected cut in the loan prime rate was limited to the 5-year tenor, which affects mortgage rates, while the 1-year rate was unchanged nL2N2XC033.

If the U.S.-China yield differential normalizes, longer-term investors should gradually start reallocating resources towards the yuan again.

Having shed as much as 6.8% of its value against the USD since the start of the year, the yuan is currently down 4.7% at 6.6694. If USD/CNY extends its pullback and closes below the 38.2% Fibonacci retracement support at 6.6378, further yuan appreciation can be expected.

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(Ewen Chew is a Reuters market analyst. The views expressed are his own.)

((ewen.chew@thomsonreuters.com))