Photographer: Philippe Lopez/AFP via Getty Images

The Bond Bulls Are Taking Over in China With 2% Yield Forecasts

  • Record advance will extend further this year, survey shows
  • There’s chance of economic growth below 6%, Guotai Junan says

There’s money to be made in Chinese bonds yet, says Zhou Li.

The China fixed-income veteran, who helped set up the nation’s debt market as a manager at the National Interbank Funding Center in the mid-1990s, predicts that a two-year sovereign rally has a long way to go. The benchmark 10-year yield will extend declines from a decade-low of 2.64 percent and possibly touch 2 percent this year as the economy slows, Zhou said. His view was among the most bullish in a survey of 24 traders and analysts, where the median estimate was for a drop to 2.5 percent.

“The Chinese economy is undergoing a fundamental restructuring, and it’s really difficult to predict when a rebound will occur,” said Zhou, chief executive officer at Shanghai Rationalstone Investment Management Co., a fixed-income fund manager with 2 billion yuan ($301 million) under management. “It’s likely that bond yields will go even lower, or at least remain at a relatively low level and become part of the new normal.”

His views back that of the domestic bond market’s top three forecasters as ranked by New Fortune Magazine -- Haitong Securities Co., China International Capital Corp. and Guotai Junan Securities Co. -- which predict that yields will slide as policy makers try to energize a faltering economy. Demand for the relative safety of government debt has been driven also by surging foreign inflows and a rising number of corporate defaults.

Chinese sovereign bonds have benefited from a global haven hunt exacerbated by Britain’s decision to leave the European Union. The Asian nation’s yields, which are high compared with negative rates in Japan and Germany, prompted global funds to boost their holdings of local debt by the most in two years in June. Domestic corporate failures have soared this year, bringing the total principal of defaulted notes to 22.5 billion yuan since 2014.

Concern that China’s economic recovery is running out of steam has added to the mix, with recent data on industrial production, fixed-asset investment and credit growth all missing estimates.

Stock investors, meanwhile, have been undeterred by the data and have lifted benchmark gauges in Shanghai, Shenzhen and Hong Kong. The Shanghai Composite Index closed above its 200-day moving average for the first time in a year on Monday amid speculation that merger activity in the real-estate industry will increase. Stocks in Shenzhen and Hong Kong rose after the securities regulator said a long-delayed exchange link between the two cities will start in 2016. Premier Li Keqiang said the State Council has approved the program, without giving a starting date, according to a statement posted on the central government’s website.

Yuan Concern

The People’s Bank of China has tried to temper expectations of monetary easing, saying on Aug. 5 that cuts to lenders’ reserve requirements would add too much liquidity to the financial system and lead to yuan depreciation expectations. A few days later, the state-run Xinhua News Agency said frequent easing through reductions to reserve ratios or interest rates is unlikely to happen in the second half of this year.

The yield on China’s 10-year sovereign bonds fell eight basis points last week and extended declines on Monday to reach the lowest level since Bloomberg started compiling ChinaBond data in 2006. Yields on 20- and 30-year debt also dropped to unprecedented levels of 3.03 percent and 3.17 percent, respectively.

The 10-year yield will touch 2.5 percent before the end of this year, according to the median estimate in the Bloomberg survey of traders and analysts conducted Monday. Shanghai Rationalstone and Guotai Junan had the most bullish predictions of 2 percent, while four including Zhongrong Wealthin Asset Management Co. were on the other end of the fence with 2.6 percent. CICC gave an estimate of 2.5 percent, while Haitong -- which wasn’t part of the survey -- has a forecast of 2.5-2.9 percent.

“There’s a chance that gross domestic product will fall below 6 percent in the third quarter, dragged down by tumbling credit growth and investments,” said Xu Hanfei, an analyst at Guotai Junan. That would be the slowest pace in more than two decades, and miss the 6.5 percent median estimate in a Bloomberg survey.

The increased demand for sovereign debt was reflected at the government’s latest issuance of 10-year securities on Aug. 3, which fetched a coupon of 2.74 percent, the lowest since at least 2004. Overseas investors increased their holdings of onshore bonds in June by 47.7 billion yuan to 764 billion yuan, latest available data from the PBOC show.

Chinese authorities have since February allowed all types of medium- to long-term overseas investors to access the interbank bond market, and said that approved fund managers under the Qualified Foreign Institutional Investors program no longer have to apply for quotas to invest onshore. The China Securities Regulatory Commission has approved 299 foreign investors for QFII since 2003, when the program started.

“The entry of foreign investors has helped boost market sentiment,” said Rationalstone’s Zhou. “While there may be periods when a rebound in inflation or signs of a stabilizing economy may weigh on the bond market, the economic restructuring, the supply side reform -- which won’t finish anytime soon -- mean yields will stay low for at least one or two years.”

— With assistance by Helen Sun

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