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China’s World-Beating Bond Rally Is at Risk From Surging Supply

China’s World-Beating Bond Rally Is at Risk From Surging Supply

The world’s best-performing sovereign bonds are set to face a liquidity test as a long-awaited spike in municipal debt issuance finally appears on the horizon.

Expectations had been building for an acceleration in local government bond sales after Chinese authorities pledged more fiscal support for a slowing economy. Still bonds rallied on the back of a surprise reduction in bank’s reserve ratio requirement and haven bids spurred by regulatory concern.

Now issuance concern as well as an unexpected rise in inflation are spooking bond investors. The 10-year yield has risen close to a three-week high, after dropping to the lowest in more than a year in early August. Some 292 billion yuan ($45.1 billion) of local government debt is scheduled to be issued this week, the highest since early June, according to data compiled by Bloomberg.

Ping An Securities estimates local debt sales in August and September may reach 1.3 trillion yuan. That compares with 1.88 trillion yuan bond sales in the first seven months of the year, or about 42% of the full-year quota, according to Bloomberg calculations based on Ministry of Finance data.

China’s World-Beating Bond Rally Is at Risk From Surging Supply

Chinese bonds have so far managed to escape supply pressures as local authorities slowed the pace of debt sales by choosing to tap on leftover funds. That’s set to change as policy makers have vowed to spend more in the second half of the year to support an economic recovery weighed by fresh virus outbreaks and faltering global demand.

“One of the factors weighing down growth in July was weak infrastructure investment due to slow issuance of local government special bonds, so an acceleration in local government bond sales is a right remedy for the current problem,” said Tommy Xie, head of Greater China research at Oversea-Chinese Banking Corp. “In terms of impact on Chinese government bonds, there might be some concerns about the supply.”

China’s state council has called for the better use of local government bond sales to expand effective investment, while a meeting of the Chinese Communist Party’s elite Politburo chaired by President Xi Jinping pledged proactive fiscal support for the economy. July saw the weakest level of government bond financing since February, a factor that weighed on aggregate financing.

“The 10-year government bond yield could consolidate in the 2.9% to 3% range,” said Stephen Chiu, Asia currency and rates strategist at Bloomberg Intelligence

©2021 Bloomberg L.P.

With assistance from Bloomberg