Morgan Stanley: Will WGBI Include China?

Morgan Stanley note that "FTSE will announce its semi-annual review result of its flagship index WGBI on September 24,and investors have been asking whether China would be included in the index and the potential inflows, given that China was on watch list in the past two reviews. In last year's review, FTSE mentioned three areas for the bond market to improve before inclusion: i) Secondary market liquidity; ii) Flexibility in FX execution; and iii) Settlement of transactions. A relatively short settlement period versus investors' preference seems to be the last hurdle, while the other two issues are less of a concern now. Overall, we believe that China has achieved enough progress in making China eligible for WGBI inclusion. However, investors' feedback and readiness would be hugely important when FTSE decides on inclusion. Therefore, we assign a subjective 60-70% probability of inclusion this September. Estimating WGBI AUM is always a debate on the Street. We use South Africa's outflows and Israel's inflows to estimate that the AUM tracking WGBI is about US$1.0-1.5 trillion. We estimate that the potential inflows into China's bond market on the back of WGBI inclusion would be US$60-90 billion, with monthly inflows of US$3-4.5 billion. While our forecast could be smaller than the Street's consensus, we believe that the importance of adding China to the global index reflects the fact that China's bond market has opened up and is easy for foreign investors to access. This supports our view that China will continue to reform its financial market and attract US$3.0 trillion of inflows in the next decade. : We expect 10yr CGBs to hold the range of 2.8-3.2%. We like receiving 1yr NDIRS and would like to add should a spike happen again. The positive BoP and PBOC's neutral view on CNY has been driving CNY stronger. We believe that the PBOC is not concerned about the current level yet but the pace of appreciation is the key to watch. We expect CNY to price in more risk premium into the US elections and use any spikes in USD/CNY to go long CNY."