MNI China Money Week: Falling Yields, Weak Data Lift Sentiment

     BEIJING (MNI) - Bond investors in China's interbank market got a double

dose of good news this week -- declining yields on negotiable certificates of

deposit (NCDs) and weak economic data -- finally giving them something to cheer

after a dismal summer.

     The average coupon yields on three-month NCDs issued by joint-stock banks

had fallen from 4.6556% on Sept. 1 to 4.2751% on Thursday, with most of the drop

coming in a sharp slump over the past week -- from 4.6164% on Friday to 4.20% on

Wednesday. That's the biggest weekly drop (in basis point terms) since the week

of June 26-30.  

     As NCD coupon rates peaked last week, the yield on 10-year Chinese

government bonds (CGB) maturing on Aug. 3, 2027, dropped 6.5 basis points last

week from 3.6650% on Tuesday to 3.60% on Friday, the biggest single weekly drop

since the issuance of the bond on Aug. 3, 2017.

     Bond investors will recognize this scenario, as CGB yields usually drop

back suddenly after NCD coupon rates reach a peak. The previous two coupon peaks

in three-month NCDs issued by joint-stock banks were June 9 and March 3, and the

yields of 10-year government treasuries saw their peaks on June 8 and March 10,

falling 16.5 basis points and 18.5 basis points in 11 and 14 days, respectively.

     Analysts attribute the correlation between NCD yields and long-term CGB

yields to the structure of market investors.

     "Asset management funds, securities companies, and other non-bank financial

institutions (NBFIs) whose liabilities are unstable [as they do not have

long-term, stable liabilities like deposit or premiums on their liabilities

side] have a big impact on bond trading," Tang Yue, an analyst for Industrial

Securities, said in a report on Monday. "So what we are witnessing is that as

the liability side of these NBFIs stabilize and liquidity conditions improve,

bond trading sentiment improves and bonds (prices) rise," as good liquidity

conditions motivate these financial institutions to buy and trade bonds, and

even increase their leverage. "When the opposite happens, the bond market

falls," Tang said. 

     Non-bank financial institutions, excluding insurance companies, hold 6.9%

of outstanding CGBs and 25.4% of policy bank bonds, according to the latest data

from Shanghai Clearing House (SCH) and China Government Securities Depository

Trust and Clearing Co.(CDC).

     "That explains the strong relationship between NCD yields and bonds

yields," as NCD yields reflect the liquidity conditions of small and medium-size

banks and non-bank financial institutions, Tang said.

     A bond trader who writes a widely read blog under the pseudonym

"Chunshenjun" said last month that watching NCD yields is more important than

tracking repo yields in the current market environment. The former offer a much

better gauge of the needs of and stresses on financial institutions and are more

relevant in the current financial deleveraging environment than the repo market,

which better reflects a bull market environment when investors are leveraging

up, the trader said.

     The pattern of NCD and CGB yields in early September has, however, shown

some divergence from the patterns in March and June. This time, the fall in NCD

yields has had a far more muted impact on CGB yields, which have already started

to rebound, and were trading at 3.6350% on Wednesday.

     Traders see tighter liquidity as the cause.

     "The market is worrying that liquidity conditions will deteriorate after

Sept. 15 because companies will have to pay taxes, and that will transfer

liquidity from the banking system to the PBOC, as taxes will be deposited in the

latter," a Beijing-based bond trader with a commercial bank told MNI.

     A trader with a commercial bank in central China added that liquidity

conditions on Wednesday had already started to deteriorate and so the tax

payments would put added pressure on the market.

     Still, it wasn't just the decline in NCD and bond yields that boosted

sentiment in the interbank market this week. Economic activity data for August

announced by the National Bureau of Statistics on Thursday gave traders another

reason to cheer.

     The data came in weaker than most investors had expected, igniting the

enthusiasm of bond investors, who took the disappointing numbers as a sign the

central bank would hold off on further tightening.

     Industrial output last month rose by 6.0% year-on-year while retail sales

rose 10.1%, both below the median estimates in MNI's survey of economists and

significantly lower than July's growth rates. Fixed-asset investment in the

first eight months of the year also came in lower than expected, rising just

7.8% year-on-year, down from 8.3% in the first seven months.

     Bond prices rose sharply in reaction to the data. The yield on one of the

most actively traded 10-year CGB maturing Aug. 3, 2027 fell 3.75 basis points on

Thursday to 3.5975%. Ten-year bond futures due in December rose by 0.41%, the

biggest rise since June 19.

     "The August data suggest the economy is trending down, and since there were

no signs of improvement compared with July data, pessimistic sentiment on the

China economy is likely to prevail," Qin Han and Xiao Chengzhe, analysts at

Guotai Junan Securities, said Friday. "If the August financial data [new bank

loans, total social financing, and M2 money supply growth] are also weak, the

bond market is likely to rebound further and for a longer time. Even if the

financial data remain strong, the market is likely to interpret it as a spent

arrow, and so the rebound of the bond market might not be stopped."

     "Bond investors did not react to the strong consumer price index number in

August while they reacted swiftly to the weak economic numbers, showing previous

expectations on strong economic conditions have been revised and bond investors

are actively looking for supporting evidence to go long on bonds," Qin and Xiao

continued. "So the market reaction tells us the tendency for the bond market to

rebound has become very clear."

     Some analysts recommended investors actively increase their bond positions.

     "Generally, we believe the fourth quarter will be a good time for bond

market -- the potential opportunities are far greater than the potential risks,"

analysts at Chinese investment bank CICC said in a report over the weekend

entitled "The Bull Market Resumes."

     "Although the bull market won't start immediately, leverage and commodity

prices have started to fall after a two-year boom and that will support the bond

market," the CICC analysts said.

     The CICC analysts said they expect bonds yields to fall by more than 20

basis points, which can be interpreted as a bond bull market.

     However, other analysts warned bond investors not to be too optimistic.

     "Weak economic conditions will only be good for the bond market if they

force the PBOC to loosen its monetary policy," analysts at Hua Chuang Securities

said on Thursday. "However, there are no signs suggesting the economic data are

so weak that the government cannot tolerate them, and there are no signs

suggesting the PBOC is about to change its monetary policy stance. So the bond

market will not rise significantly and investors need to act cautiously."

     The PBOC injected a total of CNY260 billion of liquidity into the interbank

market via its reverse repos this week.

     The yuan last traded at 6.5503 versus dollar, weakening from 6.4617 at last

Friday's closing, the first week it has weakened since Aug. 14-18. 

--MNI Beijing Bureau; +86 10 85325998; email: he.wei@marketnews.com

--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

--MNI Beijing Bureau; +86 (10) 8532-5998; email: vince.morkri@marketnews.com

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