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Manulife Favors 10-Year as Xi to Prefer Long Game: China Credit

Xi Jinping, vice president of China and general secretary of the Communist Party of China. Photographer: Lintao Zhang/Getty Images
Xi Jinping, vice president of China and general secretary of the Communist Party of China. Photographer: Lintao Zhang/Getty Images

China’s long-term bonds are rallying for the first time in four months as a pickup in the economy gives new leaders scope to shun stimulus in favor of policies that will result in slower and more sustainable growth.

The yield on benchmark 10-year notes fell six basis points to 3.52 percent in November, after climbing 29 basis points in the last three months, Chinabond data show. Manulife Asset Management said it favors notes of at least seven years duration, while PineBridge Investments and Lion Fund Management Co. predict yields on debt due 2022 have further to fall. Similar-maturity U.S. Treasuries yield 1.60 percent.

Newly-elected Communist Party leader Xi Jinping pledged last week to “carry out reforms” after investment-driven growth in the last decade enabled China to surpass Japan as the world’s second-largest economy. Xi and Li Keqiang, set to take over from Premier Wen Jiabao in March, will tolerate slower growth as they restructure the economy and the days of massive stimulus are probably over, Barclays Plc economists led by Huang Yiping said in a Nov. 15 research note.

“We prefer the longer part of the curve,” said Paula Chan, who helps manage $38 billion of Asian fixed-income assets at Manulife in Hong Kong. “Massive stimulus is out of the window completely. In order for China to become more sustainable in terms of growth the country has to transform fundamentally. The theme for the next five years will be reform. Short-term pain, long-term gain. That’s how I see it.”

Slower Growth

Gross domestic product will increase 7.7 percent this year, the smallest gain since 1999, and climb 8.1 percent in 2013, according to the median estimates of economists surveyed by Bloomberg. Annual growth averaged 10.6 percent in the last 10 years, official figures show, and was propped up at the height of the global financial crisis by a 4 trillion yuan ($641 billion) government stimulus package.

“The new leaders will place an emphasis on consistency and continuity in economic policies,” said James Zhou, a bond manager in Shenzhen at Lion Fund Management. “The economy is doing fine now and I don’t see the need for a big stimulus like in 2008,” he said, adding that 10-year yields could fall by another 10 to 20 basis points by the end of March.

The yield is seven basis points, or 0.07 percentage point, higher than this year’s average of 3.45 percent and 63 basis points above the rate for China’s one-year government debt, which yields 2.89 percent. The gap between the two maturities, which tracks the so-called yield curve, narrowed to 58 basis on Oct. 29, the smallest difference since February.

Interest Rates

The one-year yield surged 63 basis points in the last three months as policy makers held off from lowering interest rates and banks reserve requirements, even as the economy slowed for a seventh quarter. Benchmark rates were cut in June and July, while reserve ratios were lowered in May for the third time in six months.

The new leaders are likely to focus “more on the quality than the speed of economic growth,” Sun Mingchun, chief China economist at Daiwa Capital Markets, wrote in a Nov. 15 research report.

He wrote he was more concerned over the need for tighter policies than many investors, forecasting two interest-rate increases in the second half of 2013 as economic growth accelerates to 8.6 percent in the second quarter of 2013 and inflation quickens to 3.7 percent in the July-September period.

Consumer prices increased 1.7 percent from a year earlier in October, the smallest increase since January 2010, official figures show. Inflation will average 3 percent this year and 3.8 percent in 2013, Dariusz Kowalczyk, a senior strategist and regional economist at Credit Agricole CIB in Hong Kong, forecast last week.

Seeking Clarity

“The risk of holding long-duration debt is not that negative” given the pace of consumer-price gains, said Ee Leen Yueh, a Singapore-based fixed-income manager at Aberdeen Asset Management Plc, Scotland’s largest fund company. “We are positioned for slightly long durations versus our benchmark. We will probably maintain it until there’s more clarity on policy direction.”

Xi was appointed general secretary of the Communist Party at a congress last week in Beijing and said in his acceptance speech that he would carry out “reform and opening,” release production forces, raise incomes, boost social welfare and improve health provision.

Li, who holds a legal degree and translated a 1980 book on British law, has championed rapid urbanization and is associated with the World Bank’s “China 2030” report on sustaining income and productivity gains. Policy makers are seeking to deregulate interest rates, encourage private enterprise and shift to consumer-led growth.

Default Swaps

Retail sales in China increased 14.1 percent from a year earlier in the last 10 months, trailing a 20.7 percent advance in urban fixed-asset investment, official figures show.

China’s leadership changes are doing little to hurt global perceptions of its creditworthiness. Five-year credit-default swaps protecting the nation’s sovereign debt reached 62 basis points this month in New York, the lowest level since November 2010, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market. That compares with 147 basis points at the start of the year. It was at 71 basis points at the end of last week.

The yuan strengthened 0.15 percent last week to 6.2356 per dollar in Shanghai, touching a 19-year high of 6.2252 on Nov. 14. It traded little changed at 6.2345 today. The currency will rise to 6.18 by the end of next year, according to the median estimate of analysts surveyed by Bloomberg. Ten-year bonds are offering the lowest yields in a month, Chinabond data show.

“China’s economy is slowing and inflation is likely to stabilize,” said Kazuya Sugiura, the Tokyo-based president of PineBridge Investments Japan Co., part of PineBridge, which oversees about $69 billion globally. “It is reasonable for some investors to extend duration in anticipation of declines in 10-year yields.”

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