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China's Sovereign Bond Rally Is Faltering Quickly

China's Sovereign Bond Rally Is Faltering Quickly

(Bloomberg) -- Piling into China’s government bonds now looks so 2018.

The rally in the debt market is faltering quickly, with China’s sovereign bonds due in a decade headed for the biggest monthly decline since August. The securities, which were buoyed by safe-haven demand and monetary easing last year, are now faced with a barrage of new threats -- a stunning surge in equities, a better outlook on the economy and elevated interbank borrowing costs.

"Investors were excessively optimistic about bonds, and now the surge in stocks and improving economic indicators is a slap in the face," said Zhou Hao, a senior emerging markets economist at Commerzbank AG. "The yields will rise further, as traders pull cash from the money market to buy equities."

China's Sovereign Bond Rally Is Faltering Quickly

The shift in sentiment has been swift -- analysts not long ago were debating when the 10-year government yield would slide below a key level of 3 percent for the first time since 2016. China watchers have recommended investors sell bonds for stocks, as the latter will benefit from better risk appetite. Equities also look cheap relative to debt after their worst plunge in a decade last year.

Here the threats Chinese government bonds face:

  • Major benchmarks for Chinese stocks have entered bull markets, as a surge since Jan. 3 has added nearly $1.4 trillion to the value of the equities, which could encourage more investors to divert funds into buying stocks.
  • The economy is showing the first signs of recovery. Coupled with better-than-expected credit data, that means China may refrain from aggressive easing such as a benchmark interest-rate cut.
  • President Donald Trump said he was getting very close to a trade deal with China, which would further fuel risk appetite.
  • Borrowing costs are rising -- China’s overnight repurchase rate jumped to the highest level since June on Tuesday, as banks hoard funds for tax payments and investors withdraw cash to buy stocks.
  • Liquidity may get even tighter in March: lenders need to set aside cash for quarter-end regulatory checks and refinance nearly 1.9 trillion yuan of short-term interbank debt, the most in six months.
  • Local authorities may step up bond issuance this year, which means capital may flow to those securities from sovereign notes.

The yield on China’s 10-year government bonds has climbed 7 basis points this month to 3.18 percent as of Wednesday.

To contact the reporter on this story: Tian Chen in Hong Kong at tchen259@bloomberg.net

To contact the editors responsible for this story: Richard Frost at rfrost4@bloomberg.net, David Watkins, Philip Glamann

©2019 Bloomberg L.P.