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Free AccessREPEAT:MNI China Money Wk:Search for Yield Lifts Low-Rtd Bonds
Repeats Story Initially Transmitted at 08:07 GMT Aug 4/04:07 EST Aug 4
BEIJING (MNI) - Chinese institutions' search for yield and looser liquidity
conditions in the interbank market over the last few weeks has driven a mini
rally in corporate bonds, especially in the less liquid AA- rated securities.
But as the central bank moves to tighten the money spigot again, the market is
wondering just how long the good times can last.
The yields on three-year AA rated corporate bonds fell by around 66 basis
points from 5.6031% on June 1 to 4.9401% on Aug 3. The spread between AA rated
corporate bonds and AAA rated corporate bonds narrowed by 35 basis points to 42
points, while the gap between AA rated bonds and Chinese government bonds (CGBs)
shrank by 55 basis points to 147 basis points, according to data from
chinabond.com
Long-term corporate bonds with low ratings have also outperformed CGBs and
corporate bonds with high ratings. The spread between 10-year AA rated corporate
bonds and 10-year AAA corporate bonds narrowed to 72 bps from 79 bps, while that
between 10-year AA rated bonds and CGB fell to 195 bps from 221 bps.
Bonds rated AA-, which are scarcer and more illiquid, have performed even
better. The credit spread between 3-year AA- rated corporate bonds and
three-year AAA rated corporate bonds went down 49 bps from 179 bps on June 1, to
130 bps on August 3.
The main driving force behind the rally has been yield-hungry funds, whose
returns have been sliding or lagging behind what investors expected in the first
half of the year amid tighter regulation and liquidity conditions. The looser
liquidity that began in June has provided funds the opportunity to try and make
quick profits.
"If you look at the first-half performance of funds investing purely in
bonds, the median and upper-quartile of annualized yields were 2.97% and 3.77%,
which are even lower than the yields on negotiable certificates of deposit
(NCDs)," Qin Han and Liu Yi, analysts at Guotai Junan Securities, wrote in a
recent report. "So when yields on corporate bonds look like they're going to
fall, funds that haven't been performing very well become very enthusiastic and
jump in, which pushes yields down even more."
In June, funds increased their holdings of corporate bonds by CNY62.6
billion, compared with net sales of CNY167.5 billion in May, according to data
compiled by investment bank China International Capital Corp. (CICC). July data
is not yet available.
"There's a huge pool of investors who buy CGBs -- big banks, small banks,
securities companies and so on, but the investor base that trades low-rated
corporate bonds is quite small, they are mainly in it to trade and make
short-term gains," a Beijing-based bond trader at a commercial bank told MNI.
"So they tend to act in a herd-like fashion -- when they see someone jumping in,
they pile in after them to buy low-rated corporate bonds, which really pushes
yields down quickly."
CGBs are far less volatile than higher-yielding corporate bonds, so they
don't offer the same opportunity for opportunistic investors to turn a quick
profit.
Since July 1, the yield on the most-actively-traded 10-year CGB maturing on
May 4, 2027, has been trading in a narrow range of 3.55% to 3.64%, as the
People's Bank of China has managed liquidity to keep conditions within its
stated aim of "neither loose nor tight." The market has become fixated with
day-to-day liquidity conditions, watching the PBOC's open-market operations like
a hawk.
"The PBOC's management of short-term liquidity conditions has become the
focal point of the bond market," Tang Yue, an analyst at Industrial Securities,
wrote in a report this week. "Nine out of 10 bond traders and investors are
paying more attention to daily and weekly liquidity conditions than to medium-
and long-term economic conditions."
The PBOC denied liquidity to the market on Monday this week, the last day
of the month, which usually is a peak time for cash demand. That led traders to
complain of very tight conditions and there was speculation in the market that
several financial institutions were unable to buy back their repos, some traders
told MNI.
The CFETS-ICAP money market sentiment index was at 66 at Monday's close,
the highest since May 2. But by Thursday it had fallen to 33, a sign that
conditions were improving, and the PBOC started to drain liquidity on Thursday
and Friday.
"The market's still trying to come to a consensus on what this 'neither
loose nor tight' liquidity stance actually means and also how bad the
regulators' increased supervision is going to get," said the Beijing-based
trader. "We're in a bit of a wait-and-see phase, so yields on government bonds
are trading in a narrow range, treading water for now."
In this environment, buying up low-rated corporate bonds seems a risky but
rewarding option for investors who need to secure higher returns to improve
their ranking against their competitors.
"Based on our recent communications with investors, corporate bond yields
have dropped so much that they are afraid of being left behind if they don't
jump in," Guotai Junan Securities wrote in another report. "Even if their
hearts tell them to be cautious, they have to buy because of peer pressure and
performance pressure."
A survey conducted by CICC on July 27 showed that nearly 60% of investors
said they believed the best way to boost returns in the bond market was to buy
low-rated corporate bonds issued by companies that were unlikely to default.
They also said that timing their purchases and sales was crucial, as was
increasing holdings of long-term bonds in their portfolio. The CICC analysts
said they were surprised by the responses, because they felt it was very
difficult for investors to find a few good apples in a bad bunch.
A correction in the corporate bond rally over the past week -- which saw
yields on three-year AA rated corporate bonds rise from 4.8544% last Tuesday to
4.9401% this Thursday -- has been taken by many analysts as a signal that the
mini bull-run is nearing its end.
"We think government bonds and policy-bank bonds have become more
attractive than corporate bonds," Qi Sheng, a fixed-income analyst at Zhongtai
Securities, said in a report on Monday. "There's been no let-up in the
regulatory environment and liquidity conditions remain tightly balanced with no
improvement, so the leveraging-up process will be limited.
"On top of that, deleveraging in the real economy will lead investors to
demand a higher risk premium for corporate bonds. Economic conditions don't
warrant any further narrowing of credit spreads, so it's really not worth buying
corporate bonds right now."
Shenwan Hongyuan Securities analysts warned that against the background of
tight regulation, low-rated corporate bonds could be the first to suffer from
any unexpected shocks. "Investors are better off buying long-term corporate
bonds with higher ratings."
This week, the benchmark seven-day deposit repo rate, which reflects the
cost of borrowing between banks rather than all institutions in the market,
remained relatively steady this week, declining from 2.8403% on Monday to
2.7819% on Thursday and was last trading at 2.7876%.
The yuan strengthened against the U.S. dollar this week, rising by 0.37%,
the same as last week and the fourth weekly gain. It was last traded at 6.7198
on Friday, up from the close of 6.7429 last Friday.
--MNI Beijing Bureau; +86 10 85325998; email: he.wei@marketnews.com
--MNI Beijing Bureau; +44 203-586-2244; email: nerys.avery@marketnews.com
--MNI Beijing Bureau; +86 (10) 8532-5998; email: vince.morkri@marketnews.com
To read the full story
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Why MNI
MNI is the leading provider
of intelligence and analysis on the Global Fixed Income, Foreign Exchange and Energy markets. We use an innovative combination of real-time analysis, deep fundamental research and journalism to provide unique and actionable insights for traders and investors. Our "All signal, no noise" approach drives an intelligence service that is succinct and timely, which is highly regarded by our time constrained client base.Our Head Office is in London with offices in Chicago, Washington and Beijing, as well as an on the ground presence in other major financial centres across the world.