Bonds Jump Most in 21 Months as PBOC Tackles Cash Shortage: China Credit

China’s bonds rallied the most in almost two years last week as policy makers pumped funds into the financial system, easing a shortage of cash after banks were ordered twice last month to set aside more money as reserves.

The ChinaBond Treasury Bond Aggregate Total Return Index climbed 0.7 percent, the biggest gain since February 2009. The yield on the government’s benchmark 3.29 percent note due in September 2020 dropped 18 basis points from a two-year high of 4.07 percent, according to Chinabond prices. The People’s Bank of China injected 166 billion yuan ($25 billion) through open- market operations in the last three weeks.

“We judged the 4 percent yield level for 10-year bonds a buying opportunity, and that opportunity will get even better should the government use more aggressive measures to combat inflation,” said Mao Shuirong, who manages 1.58 billion yuan of funds at Huashang Fund Management Co. in Beijing.

“Prudent” monetary policies will be pursued, the state- run Xinhua News Agency reported Dec. 3, after a meeting of the ruling Communist Party’s Politburo. The government had described its stance as “moderately loose” since late 2008, a position reiterated as recently as last month by the central bank. The People’s Bank of China raised lenders’ reserve requirements for the fifth time this year on Nov. 19, a month after increasing interest rates for the first time since 2007.

Tightening Measures

China’s benchmark 10-year yield closed at a two-week low of 3.89 percent on Dec. 3 and Shenyin Wanguo Securities Co. forecast it will decline to 3.8 percent or less this month. Rates on similar-maturity bonds in Brazil dropped 28 basis points last week to 12.46 percent, Russia’s slipped two basis points to 5.80 percent and India’s climbed 21 basis points to 8.18 percent. A basis point is 0.01 percentage point.

“Concern about quickening inflation has eased a bit after the central bank’s series of tightening measures in the past two months,” said Qu Qing, a fixed-income analyst at Shenyin Wanguo in Shanghai. The “tight funding situation has also eased” since the passing of the Nov. 29 deadline for banks to comply with the last increase in their reserve ratios, he said.

Cash holdings at Chinese finance companies will also increase this month because the finance ministry usually spends more in December to complete its annual budget, according to Liu Junyu, an analyst at China Merchants Bank Co. in Shenzhen. The ministry withdrew 986 billion yuan of fiscal deposits from the central bank in December 2009 and 1.04 trillion yuan in December 2008, the most during those years, central bank data show.

New Debt Sale

The government sold 32.14 billion yuan of five-year bonds on Dec. 1 at a yield of 3.64 percent, less than the 3.7 percent median estimate in a Bloomberg survey of 15 finance companies.

“The heat in the five-year government bond sale reinforced expectations that the yield rally was temporarily over,” said Shi Lei, the head of fixed-income research in Shenzhen at Ping An Securities Co., a subsidiary of China’s second-largest insurer. “But that sentiment probably won’t last long. It’s very likely the central bank will raise interest rates after the government’s economic work conference.”

The annual conference, which will set guidelines for monetary and fiscal policies in 2011, may be held Dec. 10-12 in Beijing, the Xinhua News Agency reported Dec. 3. Consumer prices climbed 4.4 percent from a year earlier in October, the biggest gain in two years, and economists surveyed by Bloomberg forecast a 4.7 percent increase for November.

Rate Forecast

Shi predicted China will raise interest rates as many as four times by the end of next year and boost lenders’ reserve- requirement ratios three times by June 30. He forecast the yield on 10-year bonds will slip to as low as 3.85 percent, before rebounding in about a week, and said expectations of monetary tightening are driving money-market rates higher.

The seven-day repurchase rate, which measures lending costs between banks, fell 24 basis points today to 3.09 percent in a five-day decline, according to daily fixing by the National Interbank Funding Center. The three-month Shanghai interbank offered rate, or SHIBOR, climbed three basis points to 3.37 percent today, the highest level since November 2008. The rate is still lower than the one-month Shibor, which dropped five basis points to 3.77 percent.

One-year interest-rate swaps slid 10 basis points today, after dropping 27 points last week, to a nine-day low of 3.01 percent. The prior week’s closing level of 3.38 percent was the highest since August 2008.

Yuan Outlook

President Hu Jintao reiterated that the nation must balance growth with the need to restructure the nation’s economic model and control inflation expectations, Xinhua News reported Dec. 3, citing comments he made at a Nov. 30 meeting in Beijing. The central bank raised its benchmark one-year lending rate by a quarter-percentage point on Oct. 19 to 5.56 percent and the deposit rate by the same amount, to 2.5 percent.

The yuan strengthened 0.2 percent today to 6.6480 per dollar in Shanghai, bringing the gains since a two-year peg ended on June 19 to 2.4 percent, and 12-month non-deliverable forwards reflect bets for a 2.3 percent advance in the coming year.

Gradual and small yuan gains can help stabilize consumer prices in China, Sheng Songcheng, head of the central bank’s statistics and analysis department, wrote in a commentary in the Financial News newspaper today. Inflation in December will be below 5 percent and will be less than November levels, the China Securities Journal reported today, citing Zhou Wangjun, deputy director of the pricing department at the National Development and Reform Commission.

Chinese government dollar bond risk was little changed last week, credit-default swaps show. Five-year contracts on the nation’s debt traded at 69.8 basis points on Dec. 3, from 70.5 a week earlier, according to CMA prices. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to debt agreements.

--Belinda Cao, Judy Chen. Editors: James Regan, Laura Zelenko

To contact Bloomberg News staff for this story: Belinda Cao in Beijing at +86-10-6649-7570 or lcao4@bloomberg.net

To contact the editor responsible for this story: Sandy Hendry at shendry@bloomberg.net

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