Stockbrokers sit and monitor stock prices on their computer screens. (Photographer: Simon Dawson/Bloomberg)

The World’s Biggest Bond Rally Is Picking Up Steam in China

(Bloomberg) -- China’s government bonds -- the world’s best performing sovereign notes so far this year -- may have room to advance even further.

The securities will be supported by more monetary easing and stronger safe-haven demand amid lingering trade tensions, record corporate bond defaults and dropping stocks, China watchers say. The yield on 10-year sovereign notes has tumbled 51 basis points in 2018, while the costs on similar debt of most other major economies rose. Chinese yields fell 13 basis points last week, the biggest drop since April.

Policy makers have cut the reserve-requirement ratio four times this year and encouraged lending to cash-strapped private companies as the economy slows and the trade conflict with the U.S. escalates. Despite this, October’s readings of credit growth and the manufacturing purchasing managers index trailed analyst forecasts. Chinese bonds were among the worst performers in the world last year due to an official deleveraging campaign.

"China’s growth could slow further as the stimulus measures fail to kick in immediately, and that will push sovereign yields even lower," said Liu Dongliang, a senior analyst at China Merchants Bank Co., who expects the 10-year yield to drop below 3 percent in the first half of 2019. "There’s a big chance that China will cut the reserve-requirement ratio again by year-end."

The World’s Biggest Bond Rally Is Picking Up Steam in China

The 10-year government bond yield will slide to as low as 3 percent in the coming year, due to "almost unified pessimistic expectations on growth," according to Meng Xiangjuan, chief fixed-income analyst at SWS Research Co. in Shanghai. The yield was 3.39 percent as of 5:38 p.m. on Monday in Shanghai.

Investors should keep buying government and policy bank notes, which will be supported partly by more RRR reductions, Haitong Securities Co. analysts led by Jiang Chao wrote in a recent note. Jiang was among a few contrarians who accurately predicted a bull market this year.

The rally is eroding China’s yield premium over U.S. Treasuries, with the spread shrinking to the narrowest in more than eight years this month. That, coupled with a plunging yuan, is making onshore bonds less appealing to foreign investors; they became net sellers of the securities for the first time in 20 months in October. A meeting between President Xi Jinping and U.S. counterpart Donald Trump in the coming weeks could lead to a tentative trade deal, supporting risk appetite.

"The outlook is becoming increasingly uncertain after the recent rally," said Qin Han, chief fixed-income analyst at Guotai Junan Securities Co. There are risks that future economic data may turn out to be better than expected and banks may switch to buy corporate bonds as encouraged by the government, he added.

That said, bulls believe monetary easing will continue to provide support for Chinese bonds. "There’s value in bonds, especially China’s government notes," said Wei He, head of the global investment department at Chang’An International Trust Co.

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