Hungary has become the first Eastern European country to issue a yuan-denominated sovereign bond.

The deal that shows how currying favor with China may be a more important driver for the market than funding.

Reader Steve who sent me the story commented on Hungarian mortgages denominated in Swiss Francs only to see the  Franc jump over 20% in value overnight.

“Pretty clever guys!”, said Steve.

Anyone think this is a good idea?

The Wall Street Journal reports Hungary to Issue Dim-Sum Bond as It Seeks to Curry Favor With China.

Hungary priced the three-year bond at a yield of 6.25%, raising 1 billion yuan ($154 million), a small size for a sovereign deal. Bankers not involved in the transaction estimate that if Hungary issued debt in U.S. dollars and swapped the proceeds into yuan, it would have paid almost 1% less in annual interest costs.

The dim-sum market isn’t an appealing market right now. Issuance of offshore yuan bonds has been falling consistently since Beijing’s decision to devalue its currency by 2% in August last year—the prospect of another yuan devaluation has sapped much of the appeal of such bonds for offshore investors.

However, Ivan Chung, an associate managing director at Moody’s Investors Service, said selling yuan-denominated sovereign debt promotes Hungary as a yuan hub, partly by establishing a benchmark off which Hungarian firms can issue their own yuan bonds.

Bank of China opened a yuan clearing center in Budapest last October, according to China’s Xinhua News Agency, in a ceremony involving the Hungarian Prime Minister Viktor Orban and the Bank of China chairman Tian Guoli. In January this year Hungary mandated Bank of China solely for its offshore yuan bond.

This follows a pattern seen in other places. The United Kingdom issued a 3 billion offshore yuan bond in October 2014, four months after China Construction Bank said it would launch yuan clearing in London, setting up that center as a yuan-trading hub.

Sovereign dim-sum issuance also generates goodwill with China, which wants to see more cross-border finance done in yuan. In November 2013, the Canadian province of British Columbia issued a 2.5 billion one-year offshore yuan bond. The small size and short tenor didn’t do much for the province’s finances, but a banker who ran the deal said the offer promoted B.C.’s trade relations with China.

Hungary plausibly had a similar objective with its dim sum. In June 2015, Hungary was the first European country to sign a cooperation agreement for China’s “One Belt, One Road” initiative, launched with $40 billion in funding, to develop trade and transport infrastructure across Asia and beyond. This will likely mean Hungary will get linked to, and therefore benefit from, China’s infrastructure projects, and might even participate in contracts for such works.

“Hungary could use yuan to settle the trade or investment involved, such as payment for China construction firms and equipment, which could help to reduce foreign-exchange risks,” Mr. Chung added.

Valid Hedging Strategy

If corporations seek yuan-denominated bonds to mitigate currency hedging risk, such bonds may make sense.

Hedging is quite the opposite of individuals taking 30-year mortgages in other currencies.

Having a foreign-currency denominated mortgage is a purely speculative play that can (and did) blow sky high.

That said, once these things start, who knows where speculators will take them.

Another Nail in US Reserve Currency Status?

Some may trump this up as another nail in the US dollar coffin. However, in the grand scheme of things, this announcement is essentially meaningless to the US due to its small size.

Besides, having the world’s reserve currency is as much of a curse as it is a blessing.

Mike “Mish” Shedlock