MNI China Money Week: Tighter Sino/US Spread May Pressure CGBs

--As U.S. Yields Rise, 10-Yr Spread Versus China Tightens To 18-mo Low

     BEIJING (MNI) - The 10-year China-U.S. yield spread continued to tighten

this week, falling to a near 18-month low of 58 bps Wednesday, pushed lower as

U.S. Treasury yields rose to levels not seen since late 2013.

     This week's tightening leaves the spread well below the "comfort zone"

mentioned by incoming People's Bank of China governor Yi Gang on April 11, when

the spread was trading around 90 bps.

     There has been talk from some analysts that the narrowing spread will

eventually put upward pressure on China bond yields, as investors seek more

attractive yields in the risk friendlier U.S. markets. 

     Analysis shows mixed market reactions to previous periods of tighter

spreads. Charts show three times since 2010 when the 10-year spread has narrowed

below 60 bps. Twice, they snapped back quickly (in 2016 and 2017) and once

sitting at the lower levels for over 6 months (2010/11).

     --YIELD SEEKERS

     With China gradually opening up its bond market, the link between U.S. and

Chinese bonds has become stronger and the narrowing spread will undoubtedly make

China look less attractive to investors, perhaps triggering additional capital

outflow pressures.

     Letting bond yields rise to keep spreads stable is not a favourable option

for China, with officials looking to lower funding costs for corporates, which

will require stable or gradually lower bond yields. Any measures that may spook

the bond market could be detrimental.

     Rather than addressing potential capital outflow pressures by attempting to

force  bond yields higher, China could depreciate the yuan if needed. However,

at present, lower funding costs will likely be a priority for policymakers over

defending the yuan from depreciating.

     Tighter spreads of themselves will not necessarily force Chinese bond

yields higher, but the search for yield will have some impact. Investors need to

focus on China's economic fundamentals and the upcoming asset management

regulation changes, both of which could play a bigger role in how bond markets

move than concerns over the yield spread.

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

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

--MNI Singapore Bureau; +65 8233 2326; email: Asia-Editor@marketnews.com

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