Photographer: Daniel Acker/Bloomberg

China Is Curbing Its Enthusiasm for Dollar Bonds

  • Offshore demand likely to play a bigger role for market
  • Small banks’ funding squeeze diminishes their appetites

Chinese investors might have sated their appetites for now on dollar bonds, with higher returns onshore offering a better alternative, according to Deutsche Bank AG analysts after meetings in Beijing and Shanghai last week.

"Overall, enthusiasm for dollar credit has clearly dampened, especially with bank treasury desks that mainly buy investment-grade paper," Harsh Agarwal, head of Asia credit research at Deutsche Bank in Singapore, wrote in a Sept. 4 note. “We assume that the incremental demand for high-quality China IG credits is now driven more by offshore investors than onshore,” he wrote.

That marks a shift from the theme of the first half of the year, when a surge in Chinese demand was the driver of prices in the Asian dollar-bond market, which is expanding at a record pace. The dynamic was so powerful that some foreign market participants sometimes complained privately about "crowding out" from Chinese buyers.

Smaller Chinese banks are facing higher funding costs amid a crackdown by policy makers on off-balance-sheet financing, making lower yields in the dollar bond market all the less attractive for this group, according to Agarwal.

Other observations from the trip include:

  • Demand for high-yield notes and subordinated debt used as additional tier-one capital by banks is relatively "more benign" than for investment grade.
  • Among financials, onshore investors like asset management companies and leasing-company bonds.
  • In the corporate sector, they remain cautious on property due to negative headlines and Beijing’s attempt to contain price inflation, and favor local government financing vehicles “from the right provinces.”
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