By Mike Bird   What's Happening 

One-year government securities in China offered a yield of 2.611% Friday, slightly below the 2.684% offered by one-year U.S. Treasury notes. As recently as the turn of 2017, the Chinese notes offered a premium of 2 percentage points.

The shift reflects the Federal Reserve's three interest-rate increases this year. In contrast, while the People's Bank of China has kept its benchmark rate steady, the Chinese central bank has eased monetary policy in other ways, such as through reducing reserve requirements for banks, as economic growth slows.

Yields tend to affect exchange rates, as investors often flock to higher-yielding currencies, driving up their value. This year, the Chinese currency has neared 10-year lows against the dollar, as trade tensions have risen.

When it comes to 10-year bonds, Chinese debt still yields more than Treasurys. That is because prices for shorter-dated bonds have risen more steeply this year, sending yields down. While investors often consider 10-year yields as a country's benchmark interest rate, differences in short-term rates are closely watched in currency markets.

Chinese yields matter more nowadays to Western institutions. International investors have been buying the debt like never before through 2018--less because of the yields on offer and more because of its expected inclusion in major global bond indexes.

Of course, gaps between yields don't always illustrate the returns investors will actually receive: many buyers of foreign-currency bonds will hedge their exposure to swings in exchange rates with tools such as cross-currency basis swaps or forwards. China's capital controls also make it hard for its own investors to chase higher returns overseas.

What It Means

Analysts disagree on whether the yuan could weaken past seven to the dollar, a level that Beijing has previously defended.

Goldman Sachs analysts suggest the dollar will rise past seven yuan if trade tensions escalate. "In this case, the economic need and market pressure for depreciation would be so large that policy makers would likely accommodate further meaningful [yuan] weakening," the analysts wrote in a 2019 outlook.

In contrast, Morgan Stanley analysts say U.S. economic growth will slow relative to the rest of the world, limiting increases in interest rates. The bank's researchers see the yuan recovering to 6.25 per dollar by the end of 2019.

The yuan's weakness has helped feed selloffs in the equity and corporate credit markets. For Chinese companies, profits made in yuan are worth comparatively less when translated into dollars, while hard-currency debts become harder to service or repay.

Shen Hong contributed to this article.

Write to Mike Bird at Mike.Bird@wsj.com

(END) Dow Jones Newswires

November 19, 2018 00:52 ET (05:52 GMT)