The China Bond Carry Trade Returns

  • Yuan forwards implied yield slips below yield of CDB bonds
  • Gap of 30 basis points offers good carry, says ANZ analyst

The China bond carry trade is making a comeback.

The offshore yuan’s 12-month forwards’ implied yield -- a measure of the cost to protect against currency swings -- has fallen below the yield on bonds issued by China Development Bank. This means that a global fund can make money by buying the debt while being insured against any sudden moves in the exchange rate.

The cost became cheaper for the first time in almost a year in May as bonds declined amid an official deleveraging drive, with the spread swelling to 39 basis points last week -- the widest since January 2015. China has recently intensified efforts to draw foreign investors to its onshore debt market, kick-starting a trading link with Hong Kong this month and providing greater access to onshore currency derivatives for bond hedging.

“The slump in forwards points will make it cheaper for foreign investors to hedge yuan moves and buy onshore bonds," said David Qu, a market economist at Australia & New Zealand Banking Group Ltd. in Shanghai. "The points will decline further -- if they are at a level that provides 30 basis points of carry, it would be very attractive to overseas funds."

Policy makers have been trying to attract more money to the mainland as they seek to offset $1 trillion of capital outflows in the past three years. The yuan’s mixed fortunes and tighter controls have reduced the allure of Chinese debt, with overseas institutions’ holdings dropping to 830 billion yuan ($123 billion) at the end of March, compared with 853 billion yuan three months earlier.

"Now is a good time for policy makers to increase the variety of foreign-exchange derivatives," said Du Yang, a managing director at China Securities (International) Finance Holding Co. in Hong Kong. "That will boost overseas funds’ appetite for onshore bonds."

China started its bond connect with Hong Kong on July 3, with the program only allowing foreign investors to purchase onshore notes rather than the other way around. Overseas funds hold less than 1.5 percent of the 66 trillion yuan of outstanding bonds in the Chinese debt market, the third largest in the world. The onshore yuan has advanced 0.4 percent so far in July as the dollar weakened and China’s economy showed signs of improvement. The yield on China Development Bank’s one-year debt climbed for four months in a row, before declining 28 basis points in June.

"The forwards points have plunged because of improved sentiment on the yuan," said Cheng Shi, chief economist at ICBC International Holdings Ltd. in Hong Kong. "As bond yields climb amid a deleveraging campaign and hedging costs drop, foreign investors may find onshore debt more attractive."

— With assistance by Ran Li, and Tian Chen

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