China's Bond Market Is on a Comeback After Deleveraging Hit

  • Extra yield on China bonds is worth taking: AllianceBernstein
  • Deleveraging fears fade; CITIC Securities sees PBOC loosening

So much for the deleveraging scare. China’s bond market is staging a comeback, with both domestic and foreign buyers lured by the nation’s yields.

Multiple signs show a market turning steadier and more attractive. 

  • Yields on 10-year government bonds have settled at around 3.6 percent, well over a percentage point more than those on U.S. Treasuries and roughly 3 percentage points over what’s available in Europe.
  • A selloff in corporate bonds that started late last year has subsided, leaving top-rated notes paying 82 basis points more than high-grade dollar bonds from Asian issuers -- a turnaround from offering 50 basis points less in December. 
  • Bond issuance has also recovered, with July’s local sales of 694.5 billion yuan ($103 billion) back up to almost 90 percent of last year’s monthly average, according to data compiled by Bloomberg.

“It’s a good time to buy onshore China government and policy-bank bonds, against a backdrop of generally stable global bond markets,” said Brad Gibson, a fixed-income portfolio manager in Hong Kong at AllianceBernstein LP. For corporate bonds, “the current outright yield level and lack of strong policy direction from the PBOC should keep the market supported around current levels -- so there’s yield to be earned.”

Going Quiet

The People’s Bank of China started casting a shadow over the market late in 2016, scaling back liquidity and stepping up scrutiny of wealth management products, the savings vehicles that have channeled funds into bonds. While President Xi Jinping has made clear that reducing financial risks is a priority, there has been little by way of new steps on the domestic front in recent weeks. CITIC Securities Co., China’s largest brokerage, predicts looser monetary policy in the second half of 2017.

One Chinese hedge fund believes the most "violent" phase of deleveraging is now done -- read about that here.

For international investors, fading fears about continual yuan depreciation have helped boost the attraction of onshore debt, which is now easier to buy with the new Bond Connect link through Hong Kong. Even before that link began last month, foreign holdings of local Chinese bonds had hit a record high. Bank of America Merrill Lynch analysts calculate that China’s government bonds offer the best risk-adjusted return among peers in Asia.

“The additional yield available in China is worth taking,” said AllianceBernstein’s Gibson.

Falling hedging costs for going onshore are also helping. Implied yields on 12-month forward contracts for offshore yuan -- a measure of the cost to protect against currency swings -- has fallen below the yield on bonds issued by China Development Bank, one of the main state-owned so-called policy banks. This means a global fund can make money by buying the CDB notes while being insured against any sudden moves in the exchange rate.

The Chinese currency has gained about 3.4 percent against the greenback this year after a drop of 6.5 percent last year.

With a crucial Chinese Communist Party leadership gathering still pending this year, not everyone sees the financial de-risking initiative as done. HSBC Holdings Plc analysts anticipate the PBOC will boost market interest rates, sending bond prices down and 10-year government yields up to 4 percent.

Meantime, a recovery in demand for corporate bonds has pushed down the yield premium on top-rated local securities over government debt by 35 basis points from the two-year high of 141 basis points in May. Shanghai Yaozhi Asset Management LLP expects that spread to compress by another 20 basis points this quarter.

“We think credit spreads are still attractive, as corporate bond spreads are still wide if we compare with historical levels,” said Edmund Goh, a fixed-income investment manager at Aberdeen Asset Management. He prefers AAA rated short-dated notes such as commercial paper and bonds in sectors like oil and gas, power generation and grids.

— With assistance by Lianting Tu, Yuling Yang, and Ran Li

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