Daniel Altman

The Dim Sum Dollar Carry Trade

What's driving the boom market in Chinese currency bonds?


The pitch goes something like this: "Hey, buddy, want to make a quick buck? Well, have I got a deal for you! My pal, Ben, will lend you a bunch of money, see, and then you go buy some stuff from Mr. Zhou over there. You give that stuff to the Irishman. Then tomorrow, when the Irishman returns the stuff, you sell it back to Mr. Zhou at a profit and pay off Ben. So, you in?"

If you spend too much time thinking about the financial markets, like me, you’ve probably figured out that Ben is Ben Bernanke, the chairman of the Federal Reserve, and Mr. Zhou is Zhou Xiaochuan, the governor of the People’s Bank of China. You may even have twigged that the Irishman is Alan Mulally, Ford’s chief executive. Either way, you’ve undoubtedly guessed that this little vignette describes a series of transactions that can only be called the "dim sum dollar carry trade."

If you don’t spend all day and night thinking about the financial markets, your response to all of this is probably, "Excuse me, what?" But stick with me — even if you’re not a swashbuckling securities trader, the dim sum dollar carry trade affects you a great deal.

Let’s start with how the trade works. The Fed is still keeping interest rates low by injecting billions of dollars into the credit markets through purchases of publicly available securities. As of this writing, the 1-year Treasury note was yielding about 0.1 percent. It costs more than that for traders to borrow money, but not too much more. Once they borrow — and at these rates, they definitely will — the question is what they should do with the cash.

Buying "dim sum" bonds has become a frequent answer. Since 2010, businesses from around the world (including Ford) have been issuing bonds in renminbi as a way to raise money and hedge their currency risks. Many of the bonds are sold in Hong Kong, but some have gone on the market as far afield as Moscow and Sao Paulo. And these bonds have two things going for them: a relatively safe return from an investment-grade company and Mr. Zhou.

Under the stewardship of Zhou and his bosses in the Chinese Politburo, the renminbi has been allowed to appreciate moderately against the dollar every year since 2010. Except for a slight depreciation last year, the currency’s climb in value has been virtually linear. This is good news for investors who borrow dollars, trade them in for renminbi, and then use the cash to buy dim sum bonds. As the renminbi rises, so do the value of the bonds’ coupon payments and principal.

For many investors, this trade has been an almost guaranteed winner. The yields paid by the bonds themselves are not as high as they might be for dollar-denominated bonds, since the issuers are well aware of the potential gains by the renminbi. But the dim sum bonds have still been lucrative for investors — to say nothing of the banks and law firms helping to organize their sales.

At least, they were lucrative until this summer. As the days began to shorten, the dim sum story took a dark turn; issuance of the bonds slowed almost to a standstill. Between the second and third quarters of the year, new sales dropped by 88 percent. Several factors explain the sudden decline: Chinese economic growth has moderated, suggesting the renminbi will not appreciate as quickly; Chinese companies had used up their government-imposed quotas for issuance; and access to local sources of credit had improved. Yet there was one other big factor driving the slowdown that was largely unrelated to China: the taper.

Markets shuddered in June when Bernanke suggested that the Fed might slow or stop those billions of dollars in monthly purchases of securities. They weren’t reacting only to the possible effects of tighter credit on the American economy. No, if anything, an end to the purchases would have signaled that the economy was in better shape and poised for steady growth; in that situation, companies should have been seen as more profitable, not less. Rather, the markets were lamenting the end of cheap cash.

When the Fed threatened to turn off the taps, the issuers of dim sum bonds knew that demand would no longer be as strong. But investors hadn’t just used the easy money for dim sum bonds; they’d also put large chunks of it into fast-growing emerging economies. With a taper on horizon, traders knew they’d have a much tougher time generating big returns.

As a result, some of them had to sell a portion of their other holdings, especially stocks, to cover their risks. The markets took a dive, bruising the portfolios of millions of Americans, and it had nothing to do with the prospects of American companies or the domestic economy. Instead, it was because the Fed was hinting that the party was over.

All of that seems like ancient history now. Looking forward, the prospects for dim sum bonds are rosy again. The Fed has repudiated its earlier position, thanks in part to the latest fiscal crisis, and its top officials now say that any taper is a long way off. Beijing is meanwhile launching a new round of quotas for Chinese issuers. And the impending convertibility of the renminbi will push its value still higher by bolstering demand from investors, companies, central banks, and sovereign wealth funds.

Once again, traders are happy, and the markets are rising. Time for another round of dim sum? Plenty of them will say, "Yes, please!"

 Twitter: @altmandaniel

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