Bond Outlook by bridport & cie, September 21 2011

One of our colleagues recently had the opportunity to attend a two day presentation on the developments in the offshore Renminbi market. China’s Government has made a clear statement that it intends to position it’s currency as a new reference in the coming years. This could not come at a better time, as the leadership of both the Eurozone and United States has been severely tested with the current Sovereign Debt Crisis.

The objective of the Chinese Government is first to implement Renminbi internationalization, then convertibility. These are two different concepts. Internationalization could be pursued to some extent without full convertibility, whilst internationalization is not necessarily achieved even if a currency is fully convertible.

A currency can be considered international when certain soft targets have been reached in respect to;

• The influence of the country in international trade and investment markets
• The economic power of the country
• The stability of the value of the currency
• The level of development of the country’s financial markets

While China has already been successful on the first three points, an area of weakness is the depth and diversity of its financial markets. However, China’s financial markets do have strengths in terms of their size, growth and reforms.

It should be noted that the official currency in circulation in the People's Republic is the Yuan (CNY), while the term Renminbi (RMB or CNH for Hong Kong Renminbi) applies to the offshore Yuan circulating outside the People's Republic.

CNH bonds are Renminbi bonds issued on the Hong Kong exchange destined for international investors. In June 2010, the CNH bond markets gradually opened and since then have developed rapidly. Today, the daily volumes are 300 mil versus 50 mil in December 2010. So far 104 issuers have issued 332 offshore RMB bonds. Hong Kong and Chinese issuers represent the majority of the market, but well known international names such as McDonald, Tesco and BP (amongst others) have tapped this market. The average maturity is 3 years with no issue longer than 5 years. The average yield is currently 4.4%.

The investor base is very different from the EUR and USD markets. The large majority of buyers are from Asia, especially Hong Kong & Singapore (Asian investors currently represent 80% vs. 90% at the end of 2010), whilst insurance companies (which are the biggest investors in developed markets) are almost nonexistent as the market does not offer long-term bonds. Globally, banks are the overall biggest investors, with fund managers being the largest buyers of corporate bonds.

The CNH market is composed of two kinds of issues:

• Dim Sum bonds: cash flows are settled in RMB
• Synthetic bonds: cash flows are settled in foreign currencies such as the USD

Investors are looking for alternative investments as both the EUR and the USD currencies are under pressure due to the sovereign debt crisis. One year ago, many of the investors we speak to started looking for investment opportunities in RMB, and it now it seems that their demands may be satisfied. However, it should be noted that most investments are "buy and hold", due to scarce liquidity and an almost non-existent secondary market. However, given the pace of change we do not believe it will be too long before a full secondary market develops.

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Market Focus

• Global: The IMF reduced its estimate for global GDP and forecast “severe” repercussions if Europe fails to contain its debt crisis or should policy makers in the US reach an impasse over a fiscal plan. According to the IMF, the world economy will expand 4% in both this year and next. This compares with June forecasts of 4.30% for 2011 and of 4.50% for 2012

• US: The economy is forecast to expand 1.00% in 2011, down from the 2.50% projected in June, unemployment is expected to average 9% through 2012, according to the IMF. Confidence among consumers rose in September from the lowest level since November 2008. The preliminary University of Michigan index climbed to 57.8 from 55.7 in August. Retail sales stagnated in August, the unchanged reading followed a 0.30% rise in July. Payrolls fell in 30 states in August, while the unemployment rate increased in 26

• Europe: The EU reduced its growth forecasts for the second half and warned the Euro-area economy may come “close to standstill at year-end.” The Euro region is expected to expand 0.20% in Q3 and 0.10% in Q4, down from March estimates of 0.40% for both periods

• Europe: The ECB announced it will lend dollars to Euro-area banks in a series of 3 month loans in coordination with the Fed and other Central Banks. The loans are in addition to the bank’s regular 7 day dollar offerings and will be fixed-rate tenders with full allotment

• Germany: Investor confidence fell to the lowest level in over 2.50 years in September. The ZEW index of investor and analyst expectations, fell to -43.3 from -37.6

• Italy: The country’s credit rating was cut by S&P, the rating was lowered to A from A+, with a negative outlook

• Spain: Spanish banks increased their borrowings from the ECB in August. Net borrowings rose to €69.9 bln, an 11-month-high, from €52.05 bln in July

• UK: The IMF cut its economic growth forecast for this year and next, stating that the government may need to consider delaying some of its deficit-reduction measures if conditions deteriorate. The IMF expect GDP will rise 1.10% this year and 1.60% in 2012. Public-sector employment fell by a record in the Q2 publicsector payrolls dropped 111,000 in the 3 months through June, while private-sector employment rose 41,000

• BoE: The Central Bank stated that its bond- purchase plan had “economically significant” effects on Britain’s financial system. The BoE suggested that the £200 bln of securities bought since March 2009 had increased GDP by between 1.50% and 2.00%, and increased inflation by approximately 1%

• Market: It is relevant to highlight that the CDS market is not consistent with the cash market. For example, Colombia (BBB-) 5 year CDS trades at 172bp, Thailand (BBB-) at 168bp and Mexico (BBB) at 173 bp, while French (AAA) CDS are above these levels at 185bp. On the cash market, the picture is different: in EUR, the French D/Govt for bonds maturing in 2017 is around 74 bp vs. 265 bp on Mexican bonds, or in USD the Colombia 2017 trades at +188 bp vs. +65bp for a Cades bonds

Disclaimer
This document is based on sources believed to be reliable, accurate and complete. Any information in this document is purely indicative. This document is not a contractual document and/or any form of recommendation. Expressions of opinion herein are subject to change without notice. We strongly advise prospective investors to consider the suitability of the financial instruments, based on the risks inherent to the product and based on their own judgment. It is not intended for publication. This document may not be passed on or disclosed to any other third party without the prior consent of bridport & cie s.a. © bridport & cie s.a.

September 21, 2011

Caroline Weber, CFA