(Yicai Global) Aug. 5 -- Yuan bonds, China’s domestically-traded A-shares, and other emerging market stocks and bonds as well as gold and silver are becoming the focus of global asset allocation with the China-US interest rate spread reaching new highs and the US dollar index dropping.

The China-US interest rate spread climbed to a historical high of over 240 basis points, while the US dollar index fell to a two-year low of 93.4 yesterday.

International institutions are gradually turning to emerging markets against this backdrop, and the rise in yuan bonds ranks first in the world. A-shares, which gained the world’s top income this year, are enticing overseas investors to continue upping their stakes. Gold has soared by more than half since November 2018, several sources from international institutions told Yicai Global.

The key precondition for this situation is that US monetary policy remains loose as China’s turns from loose to neutral.

China did not express many signs of easing monetary policy, but emphasized flexibility and appropriateness and precise guidance, and slashed overall financing costs at the Politburo meeting at the end of last month. This means that the price of money will remain near the policy interest rate in the second half, said Xia Yinyin, Chinese interest rate market strategist at UBS Securities.

The China-US interest rate spread will stay high. China's 10-year treasury bond yield was 2.968 percent, while the 10-year US’ was 0.544 percent, and the interest rate spread exceeded 240 bips on Aug. 4.

Funds will flow out of developed markets and pool in emerging market bonds seeking higher returns when the US economy becomes weak.

The US money market fund hit a record-high outflow of funds in a single week since July 13, with a net drain of USD87 billion.

Risky Business

This large outwash of broad money funds shows investors may have begun to prepare to allocate cash to risk assets. The amount of funds fleeing to the local currency bond market in emerging markets is still limited and volatile, but yuan bonds have become the most popular investment target, said Zhang Meng, a macroeconomics and foreign exchange strategist at Standard Chartered.

The weight of yuan bonds in the international bond index rose from 4 percent before to 5 percent at the end of last month, and will rise to 10 percent by year’s end, Zhang predicted.

A-shares proved their attractiveness with the world's number one earnings this year. Investors will invest in areas with better fundamentals, said Zhao Yaoting, a global market strategist at Invesco Asia Pacific. The current price-earnings ratio of the CSI 300 index, which tracks the top 300 shares traded on the Shanghai and Shenzhen stock exchanges, is still about 40 percent discounted from the S&P 500 index, which is their largest valuation differential since April 2014.

The second wave of the Covid-19 pandemic in the US and its negative economic impact are worrying, but the stock market has not accurately discounted this, which poses a huge risk, Zhang added.

The real yields of US treasuries have fallen sharply over the past two years, which has spiked the bull market in gold. Real yields of US treasuries are still falling while a nascent weak US dollar has boosted gold, whose prices may gain support again if US dollar inflation further rises, industry insiders noted.

The number of global negative-yield bonds is growing, and more institutions are electing to increase their holdings of non-interest-bearing gold, said Terry Pan, chief executive of Invesco’s China, Southeast Asia and Korea regional business.

Editor: Ben Armour