By Winni Zhou, Tom Westbrook and Brenda Goh
SHANGHAI/SINGAPORE (Reuters) - Bond markets are putting Chinese and global rates on opposite paths, speculating on cuts in China against hikes in the U.S. and prompting banks and Chinese companies to prepare for a weaker currency as Beijing rolls out more stimulus.
The yuan fell past the closely-watched seven-per-dollar level last month and hasn't stopped, as China's post-pandemic economic recovery falters amid weak demand at home and abroad.
This week it hit a six-month low on the dollar after surprise cuts to key China rates, putting the gap between 10-year sovereign yields in China and the U.S. at its widest since November. The gap with British yields is the widest in 16 years.
The position, with China's rates below those in the United States, is the reverse of more than a decade of high-growth that saw China paying better yields than markets in the west.
That it is failing to unwind as the pandemic recedes has caught many off guard and -- along with the speed of the yuan's recent slide -- has investment banks cutting currency forecasts and analysts seeing risks ahead as companies hoard dollars.
"(The yuan) is set to remain pressured by structurally negative carry that handicaps supportive flows including foreign portfolio investment bond inflows and corporate dollar selling," said J.P. Morgan analysts in a note.
"The People's Bank of China's tolerance of currency weakness ... also opens up room for further yuan weakness." J.P. Morgan recently downgraded its year-end yuan forecast, from 6.85 per dollar to 7.25 per dollar.
The yuan has lost nearly 4% so far this year to 7.1674 per dollar on Wednesday, making it one of the worst performing Asian currencies, as China's widely touted post-COVID recovery quickly lost steam.
Some investment banks expect the yuan to end the year as weak as 7.3 - a level seen in November when China's borders were shut and strict health policies disrupted economic activity.
That would imply a further 1.8% depreciation.
The People's Bank of China did not immediately respond to Reuters request for comments on banks' cuts to yuan forecasts or risks to the currency from corporates' positioning.
RISK FACTOR
Policy action and expectations are driving the rates and currency markets to move in tandem in anticipation that western economies will continue to struggle to rein in inflation and keep policy settings tight, while China will be struggling to replicate its pre-pandemic growth.
Even if the Federal Reserve holds rates steady later on Wednesday, as expected, traders are braced for an extended period of elevated U.S. interest rates and, increasingly, for China to hold rates low or push them even lower.