China Rate Cut Brewing Makes Yuan Sovereign Bonds Best in Asia

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China’s bonds are delivering Asia’s best returns as investors bet the central bank will soon add to its two interest-rate cuts since November.

The country’s sovereign debt gained 1.5 percent in April, while securities in South Korea, Indonesia and the Philippines lost money, Bloomberg indexes show. The yield on 10-year Chinese treasury bonds tumbled 30 basis points to 3.35 percent, the most since October 2008. HSBC Holdings Plc and Guosen Securities Co. predict the rate will drop to 3.2 percent by end-June, the lowest of 13 estimates in a Bloomberg survey.

China is loosening monetary policy to revive the slowest economic growth in two decades and bolster demand for fixed-income securities as local governments prepare to sell more than

1.7 trillion yuan ($274 billion) of debt this year. Huatai Securities Co. predicts the People’s Bank of China will cut interest rates by mid-May, while Standard Chartered Plc forecast a reduction by the end of June.

“Expectations that there will be an interest-rate cut in the near term are fermenting,” said Yu Pingkang, an economist at Huatai in Shenzhen. “The economic outlook is tough.”

Money-market rates have more than halved this year as the PBOC cut banks’ reserve ratios twice, freeing up funds. The seven-day repurchase rate fell 263 basis points since Dec. 31 and sank to a 13-month low of 2.29 percent on Tuesday. The one-year swap, the fixed cost to receive the repo rate for 12 months, dropped to 2.5 percent on Monday, matching the PBOC’s benchmark deposit rate for the first time since just before the easing cycle began in November.

Slowing Growth

A report this week showing manufacturing lost momentum prompted ING Groep NV’s Tim Condon to review his 7 percent economic growth estimate for the three months through June. He predicts the PBOC will cut interest rates and lenders’ reserve requirements every quarter this year. Gross domestic product rose 7.4 percent last year, the smallest annual gain since 1990, and was 7 percent in the January-March period.

Imports, a barometer of domestic demand, probably declined for a sixth month in April, falling 11.6 percent from a year earlier, based on the median estimate in a Bloomberg survey before trade data due Friday. There is scope to cut interest rates this quarter, according to a front-page commentary published Tuesday in the China Securities Journal.

Recent Consensus

“It only recently became a consensus in the market that monetary conditions will loosen and interest rates will go down,” said Xiaoning Meng, a Hong Kong-based fund manager at CSOP Asset Management Ltd. “From January to March, economic fundamentals weren’t good either, but the PBOC’s measures were less direct.”

The PBOC has room to prop up the bond market. Its balance sheet has grown 16 percent in two years, less than the 96 percent for the Bank of Japan and 44 percent for the Federal Reserve, data compiled by Bloomberg show. The country had $3.73 trillion of foreign-exchange reserves at the end of March, more than triple the size of any other country’s holdings.

BlackRock Inc. favors onshore Chinese government bonds given the nation’s low “sovereign leverage” and solid foreign reserves, said Rick Rieder, chief investment officer of fixed income, fundamental portfolios at BlackRock Inc., which oversees $4.77 trillion of assets globally.

China’s economic growth in the first quarter conformed to expectations, the official Xinhua News Agency reported, citing a Politburo meeting last week at which President Xi Jinping presided. China will “fine tune” its policies and maintain continuity and stability, Xinhua said. The government set an annual expansion target of 7 percent for 2015.

“The risk is if the policy catch-up turns out to be too little too late, it may take us until the third quarter to see a material rebound, posing more risks to the full-year GDP target,” Julia Wang and Qu Hongbin, Hong Kong-based economists at HSBC, wrote in a note on Tuesday. They predict another 25 basis-point cut in benchmark interest rates this quarter, adding that a move is “likely sooner rather than later.”

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