Investors in Chinese bonds head into next year betting there would be no miraculous recovery in the economy, putting them at odds with an equities market that has wagered on a revival in consumption.
Although China’s closed capital account diminishes the 33 trillion yuan (US$4.53 trillion) market’s worth as an economic forecaster, the signal from 10-year bond yields scraping record lows almost daily and long bonds falling below Japanese yields still shows a deep-set negativity about the outlook.
“The bonds are basically saying that, yes, there is a [stock market] rally out there, but we don’t buy this rally for the long term,” said Bhanu Baweja, chief strategist for UBS Investment Bank in London.
“Bonds are saying that this is not an earnings-based rally, this is not a reflation-based rally,” he said.
A benchmark 10-year yield down more than 80 basis points this year to a record low of 1.78 percent reflects a banking system overflowing with cash and a market broadly expecting slow growth and hardly any inflation.
Bond prices move inversely to yields and, because sovereign debt is regarded as a safe asset, they are affected by a combination of inflation expectations, interest rates, creditworthiness and appetite for risk in other asset classes.
Since September, as China has cut interest rates and made numerous promises to stabilize financial and property markets, boost economic growth and revive consumption, equity markets have rallied and pushed price-to-earnings ratios sharply higher.
Bonds have made an almost opposite move, particularly at the long end where 30-year yields have been driven below 2 percent. Thirty-year yields in Japan, an economy which has become a byword for deflation and slow growth, are 2.24 percent.
“I think the Chinese bond yields should be lower if they were to reflect the current economic situation in the country,” said Edmund Goh, investment director of fixed income at abrdn in Singapore.
“We think it’s difficult to see meaningful inflation given the property situation in China now and the government is determined not to create another property bubble,” he said.
In March, China’s government set a growth target of “around 5 percent” for this year, but the world’s second-biggest economy has struggled for momentum and grew just 4.6 percent in the third quarter.
Goldman Sachs sees growth slowing to 4.5 percent next year.
Part of the backdrop to the bond rally is a lack of alternatives. Chinese banks are bursting with more than 300 trillion yuan in deposits, and with loan growth in the doldrums, much of that ends up flowing to money markets and bonds — pushing down yields.
The yield on the popular Tianhong Yu’Ebao (天弘餘額寶) money fund, which is China’s largest with more than 600 million investors, hit a record low at 1.266 percent this week.
“Onshore lenders are facing the question of whether to give out loans to businesses, or to play it safe with risk-free Chinese government bonds,” said Clarissa Teng, fixed income allocation strategist at the chief investment office of UBS global wealth management in Hong Kong.
“Many are doing the latter, especially given that credit demand from households and corporates has been soft as well,” Teng said.
Risks to the bond market are some of the same factors supporting equities — that China unveils a large fiscal spending plan which requires extra borrowing and leads to higher inflation, both of which are negative for bonds.
China’s central bank has also sounded uncomfortable with the scale of the rally and has actively sold bonds to slow it down. Foreign investors, including BlackRock, have also been sellers in part to take some profits after the long rally.
Still, most investors say the path of least resistance is for the rally to continue with Li Kai (李凱), chief investment officer of Beijing Shengao Fund Management (深高基金管理), expecting a 10-year yield of 1.6 percent next year and others confident in their positions.
“We’re struggling to find much reason to be pessimistic about the sovereign bond market,” analysts at Shanghai-based Shoupu Asset Management (守樸資產管理) said in a letter to investors last month.
“The facts of economic fundamentals are out there, and without strong, targeted growth-stabilizing policies, there is little resistance to the decline in bond yields,” they said.
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