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--Short-Term Bond Outlook Positive, Longer-Term Outlook Cautious
     BEIJING (MNI)   - The Chinese bond market stumbled at the start of the new
year, with long-term bond yields rising sharply, due mainly to short-term
technical issues and continued regulatory concerns.
     Analysts predicted that bonds could rally in the first quarter due to
fundamental supply and demand factors, though they cautioned that the
longer-term outlook remains bearish. 
     --BOND DIVE
     The yield on the most-actively-traded 10-year China government bond rose to
3.9325% on Thursday, up 5.25 basis points from last Friday, while that on the
most-traded China Development Bank 10-year bond rose to 4.9425%, up 13.25 basis
points from a week earlier. The rise in the CDB yield was the largest since the
end of November.
     The price of Chinese government bond forwards maturing in March also
declined sharply, with the five-year dropping to 96.25 from 96.605 the previous
Friday and the 10-year to 92.465 from 93.165. 
     The deterioration in the bond market came despite very good liquidity
conditions this week. The benchmark seven-day deposit repo (drepo), reflecting
the borrowing costs of banks, averaged 2.732% this week through Thursday, the
lowest since April last year. The seven-day repo, reflecting the borrowing costs
of all financial institutions, averaged 3.0152% this week through Thursday, the
lowest since early July.
     "Although liquidity has been pretty loose recently, the bond market is
still in a cautious mood," a Beijing-based bond trader at an asset management
company said. "The concern that liquidity will be tightened again and the fear
of stronger regulation are both preventing investors from purchasing bonds."
     There were three main reasons for the bond market decline this past week.
     First, preliminary economic data for December was quite strong against
market expectations for a gradual easing in growth. The Caixin Manufacturing and
Services PMIs rose to 51.5 and 53.9, respectively, much higher than market
     Second, the intentional delay in necessary position adjustments by
financial institutions until after the end of the year likely caused intense
selling pressure in the first week of January.
     "As Dec. 31 is the date when financial institutions must record the
performance of their investment portfolios, some may not have wanted to sell
large quantities of bonds [before that date] as that would have reduced bond
prices and caused the value of their portfolios to fall, especially when the
bond market is quite weak," Ming Ming, an analyst at CITIC Securities, said in a
research note on Tuesday. "So postponed selling pressure caused bond market
yields to rise in the first week of 2018."
     Third, the Chinese Development Bank restarted its issuance of 10-year bonds
on Thursday, igniting traders' interest in shorting those bonds (See Dec. 22
China Money Week: CDB's Yield Curve Push Won't Help).
     "The reopening of 10-year CDB bond issuance, along with rising stocks and
commodities, encouraged investors to sell bond forwards short," analysts at
Guotai Junan Securities said in a report on Tuesday. "As current bond market
sentiment is very weak, falling bond forwards caused bonds to fall, a
self-reinforcing process."
     Thursday's auction results confirmed the weak demand for the 10-year CDB
bonds, with the yield bid at a relatively high 4.9052%, up from 4.7063% at the
last similar auction on Nov. 14, and total bid volume at only 2.33 times total
issuance volume of the bond. The result was described by one bond trader as a
"very bad," indicating that demand for long-term bonds is still weak.
     What now worries bond traders most is the potential for stronger
regulations in the future.
     "The bond market was not very sensitive to regulatory policies before April
last year, but the escalating regulatory efforts have made bond investors really
cautious about regulators' moves," said a Shanghai-based bond trader at a
securities company. "I think the bond market will only stop falling when this
fear gradually disappears."
     But regulatory pressure shows no signs of easing. The People's Bank of
China has enacted strict limits on the issuance of negotiable certificates of
deposit (NCDs), which forced banks to sharply cut their NCD issuance last year
and is expected to do so again this year. In addition, the final version of the
regulation on asset management products is expected to come out soon, probably
this month, and the market does not expect the final version to be any less
strict than the draft published in December.
     However, some analysts argued there is no need to worry about the bond
market outlook in the near term. 
     "The PBOC is trying to prevent new risks through financial deleveraging, so
the regulation will not have too big impact in spooking the market in the
short-term," CITIC Securities' Ming said. "And as liquidity conditions are
likely to remain in a slightly relaxed state until the Spring Festival holiday
[which starts Feb. 16], 10-year CGB bond yields will likely fall closer to
     Some short-term trading opportunities also exist, according to analysts.
     "Bond market sentiment might improve as liquidity conditions get better and
the targeted required reserve ratio cut becomes effective," analysts at China
International Capital Corp. said in their research note on Thursday. 
     Under the targeted required reserve ratio cut, banks that meet minimum
levels for lending to the agricultural sector and micro- to small-sized
companies saw their reserve requirement ratios lowered by 50 basis points from
Jan. 1. Banks that meet higher lending levels for these sectors will see their
RRR cut 100 basis points.
     In addition, a "temporary required reserves usage arrangement" was
announced earlier to allow national commercial banks that suffer a temporary
liquidity crunch during the Chinese News Year season to temporarily take out and
use no more than two percentage points of their required reserves parked in the
PBOC for a period of 30 days, which will also help to alleviate any liquidity
shortages before the holiday as cash needs surge.
     "In terms of bond supply and demand, bond supply is relatively low in the
first quarter, while demand could be strong because insurance companies will
absorb a large amount of funds in the first quarter, causing demand to rise
compared with supply and so providing trading opportunities for bond investors,"
CICC said. 
     But in the longer term, bond investors should remain patient.
     "Strict regulations, a prudent and neutral monetary policy, along with
resilient fundamental economic conditions, will lead to a relatively stable bond
market in the short term, and better liquidity conditions might even lead to a
short-term rebound of the bond market," analysts at Industrial Securities wrote
in a report on Tuesday. 
     "However, as long-term funding for the banking system is still lacking, and
funding demand will not weaken dramatically because of resilient economic
conditions, the bond bear market is not over," they warned. 
--MNI BEIJING Bureau; +1 202-371-2121; email:
--MNI Beijing Bureau; +86 10 85325998; email:
--MNI Beijing Bureau; +86 (10) 8532-5998; email:
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