(Yicai Global) June 2 -- The United States Federal Reserve began to shrink its balance sheet yesterday. Analysts suggest that funds are likely to flow out of emerging markets but those coming out of China will be slower due to the country’s loose policies.

Industry insiders generally believe that China’s economy is likely to bottom at the end of May and rise this month. After the completion of profit revision in the second quarter, the nation’s capital market may also usher in a turnaround.

According to an interest rate decision released by the Fed last month, a new round of quantitative tightening will start on June 1 to shrink its balance sheet by USD47.5 billion a month. It will gradually raise the figure to USD95 billion in three months, comprising USD60 billion in government bonds and USD35 billion MBS.

In the context of the Fed’s interest rate hike and balance sheet reduction, international funds are likely to flow out of emerging markets. Overseas investors have been reducing their holdings of Chinese yuan-denominated bonds since February and had cut nearly CNY300 billion (USD44.9 billion) as of the end of April, public data shows

However, this outflow rate will not continue in the second half of this year, according to Zhang Meng, a macro and foreign exchange strategist at Barclays China.

Fund inflows due to the inclusion of Chinese government bonds into the FTSE Russell World Government Bond Index will continue to offset some of the outflows, Zhang told Yicai Global, predicting that around USD10 billion will be invested in Chinese government bonds in each quarter through the fourth quarter of 2024.

The outflow of foreign funds from China’s stock markets has been slowing down significantly since late May. The net inflow of northbound funds totaled CNY13.9 billion on May 31 and CNY1.2 billion yesterday, raising the total net inflow in the second quarter to CNY24.4 billion.

China has provided more macro-policy support for stock markets since mid-May, and market sentiment has recovered, Meng Lei, China strategist at UBS Securities, told Yicai Global.

There is no need to worry too much about short-term exchange rate fluctuations, industry insiders observed, noting that China’s central bank has many expected management tools such as issuing offshore central bank bills and cutting the foreign exchange reserve requirement ratio. Foreign banks generally forecast that the exchange rate of the yuan against the US dollar will be between 6.6 and 6.9 at the end of the year.

China has maintained a current account surplus this year, which is expected to continue through this year and 2023, Liu Li’nan, managing director of Deutsche Bank, said, adding that from January to April, China’s foreign direct investment rose by 20.5 percent year-on-year.

All these factors have basically kept the yuan exchange rate stable, Liu pointed out.

The International Monetary Fund raised the yuan’s weighting in the Special Drawing Rights basket from 10.92 percent to 12.28 percent on May 14. The huge jump is good for the yuan, Liu suggested, estimating overseas investors, especially medium- and long-term investors, will continue to be net buyers of yuan-denominated assets.

Editor: Peter Thomas