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China’s Lowest Bond Yields Since 2016 Look Really Juicy to Some

The bull case for Chinese bonds may be tempered by the yuan, as well as risks in the credit market.

China’s Lowest Bond Yields Since 2016 Look Really Juicy to Some
A man holds wooden chopsticks above a plate of Chinese one-hundred yuan banknotes on a black background in this arranged photograph in Hong Kong, China. (Photographer: Paul Yeung/Bloomberg)

(Bloomberg) -- China’s benchmark government debt is the closest in years to yielding just 3%.

Escalations in global trade tensions since April have put a damper on sentiment, helping spur a rally in Chinese sovereign bonds. The yield on the country’s 10-year debt is down about 40 basis points since a peak that month, falling as low as 3.03% Friday. It hasn’t traded below the 3% threshold since November 2016.

The returns still stand out for bond investors just as a record $15 trillion of the world’s debt yields less than zero. While bulls are expecting China to add stimulus to counter the economic risks of a protracted trade war with the U.S., the People’s Bank of China signaled Friday it will hold back from deploying large-scale measures. Retail sales and credit data due this week are forecast to confirm a slowdown in growth.

The bull case for Chinese bonds may be tempered by the yuan, as well as risks in the credit market. While the currency slump last week did little to hold back the rally, there’s concern that further depreciation could keep foreign buyers away, even if the cost to hedge the yuan remains near its lowest since 2014. Donald Trump has threatened more tariffs and surprise interest-rate cuts around the world have stoked fear of a currency war.

Credit risks at home include the kind that were sparked by the sudden seizure of a small Chinese bank in May, rippling across credit markets. The event also tightened interbank liquidity and forced financial institutions to sell holdings of sovereign bonds for cash.

The yield on China’s 10-year government bonds was steady at 3.03% as of 5:06 p.m. in Shanghai.

China’s Lowest Bond Yields Since 2016 Look Really Juicy to Some

Here’s what some fund managers say:

UBS Asset Management (Hayden Briscoe, head of Asia-Pacific fixed income)

  • Chinese debt is probably the best asset now among global government bonds
  • Investors should keep adding the debt as hedging costs are very low relative to returns
  • China’s 10-year sovereign yield will break 3% in the near term
  • PBOC will cut the reserve-requirement ratio and rates for open-market operations and its medium-term loans to banks in the second half of the year

Pictet Asset Management (Cary Yeung, head of Greater China debt)

  • Positive on both the yuan and Chinese sovereign bonds
  • Downside of yields is limited given China won’t loosen aggressively, while upside is also constrained as the economy slows
  • Appetite for yuan-denominated debt will likely return once the currency stabilizes; the yuan will be buttressed by foreign capital inflows, as onshore bonds get included in global indexes
  • China will support its interest rates at "relatively higher level," though the Fed may cut borrowing costs in September, as Beijing doesn’t want leverage to rise
  • Yeung is expanding his team as yuan assets become more mainstream

BNP Paribas Asset Management (Jean-Charles Sambor, deputy head of emerging-market fixed income)

  • Cautious for now, though optimistic on Chinese debt in the long term
  • China will see $300 billion of inflows into its onshore bond market in the next two to three years
  • It may not be the right time to add more debt now as Chinese bonds have rallied strongly recently
  • Yuan will stabilize around 7 in the near term as Beijing knows a weak currency will lead to capital outflows
  • Investors should buy if the 10-year government bond yield rises to 3.15% to 3.2%

Nissay Asset Management (Toshinobu Chiba, chief portfolio manager of fixed-income investment department)

  • China’s 10-year sovereign yield will drop to 2.6% to 2.9% by year-end as the central bank eases further due to the trade war and weakening economy
  • Index players and active managers will keep buying Chinese bonds because of index inclusions
  • Chiba’s firm is underweight Chinese credit, especially bank papers, due to sluggish fundamentals

Aberdeen Standard Investments (Edmund Goh, Asia fixed-income fund manager)

  • Bullish on Chinese government debt and has some currency risk hedged in his investments; "we added more Chinese government bond risk recently before and after the yuan slid past 7": Goh
  • The trade war escalation "surprised" Goh, but convinced him that China’s economic slowdown will be prolonged
  • China won’t use yuan depreciation to fight the trade war as it needs stable capital flows for now

--With assistance from Yuling Yang and Claire Che.

To contact the reporters on this story: Tian Chen in Hong Kong at tchen259@bloomberg.net;Qingqi She in Shanghai at qshe@bloomberg.net

To contact the editors responsible for this story: Sofia Horta e Costa at shortaecosta@bloomberg.net, Magdalene Fung

©2019 Bloomberg L.P.