China’s eight-quarter-long bond rally is facing the twin threat of increased sales and reduced demand as the nation’s leaders intensify efforts to stimulate growth in the world’s second-largest economy.
A decision over the weekend to widen the government’s fiscal deficit to a record 3% from last year’s 2.3% will spur a surge in debt issuance that will push up yields, said China Merchants Securities Co analyst Sun Binbin. Accelerating inflation and a jump in credit that is seen as positive for the economy are other factors that bond investors need to consider, according to Haitong Securities Co.
The Bloomberg China Sovereign Bond Index has risen every quarter since the beginning of 2014, handing investors a return of 20% through the end of last year, compared with 7% for US Treasuries. The People’s Bank of China has cut interest rates six times since November 2014 and eased reserve- requirement ratios. Record-low interest rates prompted investors to borrow more, driving total debt to 247% of gross domestic product in 2015 and 10-year sovereign yields to the least in seven years.
“Given the various pro-growth measures, the economy is likely to stabilise later this year, driving up inflation and weighing on the bond market,” said Wei Taiyuan, an investment manager at China Merchants Bank Co in Shanghai. “Yields are already very low and challenges to the economy have already been priced in. The bond market will probably trade range bound at best.”
The yield on the benchmark 10-year sovereign note fell 173 basis points in the last two years and touched a seven-year low of 2.72% on January 13, ChinaBond data show.
The yield on notes due January 2026 climbed one basis point to a one-month high of 2.95% in Shanghai, according to National Interbank Funding Center prices.
Premier Li Keqiang is trying to resuscitate an economy growing at the slowest pace in 25 years, while seeking to avoid runaway credit expansion that would risk financial instability.
Speaking at the National People’s Congress this weekend, he outlined a 6.5% to 7% growth range for this year, with 6.5% pegged as the baseline through 2020. That would be less than last year’s 6.9% expansion, which was the least since 1990.
Central government debt will grow 18% this year, up from 11% in 2015, while gross municipal bond issuance will jump 63%, according to Bloomberg calculations based on budget projections.
Local government bond sales will increase to 1.18tn yuan from 600bn yuan last year. This is in addition to about 5tn yuan of regional debt due this year that will be swapped into municipal notes. The swap programme was 3.2tn yuan last year.
“A larger fiscal deficit, both nominal and actual, together with more bond issuance and other innovative fiscal expansionary measures, reflects a significant expansion of fiscal policy,” Qu Hongbin, Hong Kong-based chief China economist at HSBC Holdings, wrote in a note on Monday. “This will provide greater support to the financing needs of infrastructure projects, which holds the key to stabilise growth.”
The nation’s broadest measure of new credit surged to a record 3.42tn yuan in January as a seasonal lending binge coincided with a recovery in the property industry.
Home prices in Shenzhen, China’s southern business centre in Guangdong province, have jumped 52% over the past year, while those in Shanghai surged 18%. In a report released March 5, policy makers set the M2 money supply expansion target at 13%, compared with last year’s 12%.
Keeping the monetary base target markedly above nominal gross domestic product growth points to a further increase in leverage in the economy which risks raising contingent liabilities for the government, according to Marie Diron, senior vice president at Moody’s Investors Service. The rating firm last week lowered China’s credit-rating outlook to negative from stable.
“A bigger increase in money supply will translate into larger demand for assets, including property and commodities,” said Ji Tianhe, a Beijing-based analyst at Founder Cifco Futures Co. “Among all the choices, bonds are the least attractive, as the current yields are too low.”