China Bond Rally Gains Momentum as Risks Show Up Everywhere

Livia Yap
·3 min read

(Bloomberg) -- Traders in China are flocking to sovereign bonds as an expanding regulatory crackdown and concern that growth is slowing pressure risk markets.

The yield on benchmark 10-year government debt fell to the lowest in a year as stock indexes in China and Hong Kong declined by over 3%. High-yield dollar bonds dropped as much as 2 cents on the dollar.

A sudden policy change on education companies coming on top of crackdowns on technology firms, curbs in financing for the property sector, and signs of an expanding Covid-19 outbreak are building a narrative that a wide swathe of Chinese assets are under threat. Meanwhile, some July economic indicators show signs of weakness.

“The market is concerned about regulation tightening which might drag down growth in the coming quarters,” said Hao Zhou, senior emerging markets economist at Commerzbank AG in Singapore. “The policy uncertainties derived from the crackdown on private tuition has also dampened the sentiment.”

Stock traders are finding fewer options to invest in, with concerns leaping from technology to property to education and consumer sectors as Beijing overhauls broad parts of the economy in pursuit of what is seen as a more equal society.

On Monday, the government issued regulations asking food delivery companies ensure a local minimum wage for their workers. That came after new rules released over the weekend banning companies that teach school curriculum from making profits. Meanwhile, signs of a cash crunch at China Evergrande Group has stoked contagion fears and hurt high-yield credit.

The shift to risk-off trading is adding to a rally in China bonds, which began earlier this month on expectations that authorities will ease liquidity to support growth. The People’s Bank of China is forecast to cut the reserve requirement ratio for banks once more this year after a surprise reduction in July, according to a survey of economists by Bloomberg.

Read: China’s World-Beating Bond Rally Set to Extend on Easing Bets

“Beijing has already cut the reserve requirement ratio and we expect it to introduce additional monetary and fiscal easing measures,” said Ting Lu, chief China economist at Nomura Holdings Inc. in Hong Kong. The economy “will face significant risks in coming months due to the unprecedented tightening measures applied to the property sector,” he said.

China’s CSI 300 Index fell 3.2%, the most since March, while Hong Kong’s Hang Seng Index dropped 4.1%. Futures for 10-year government bonds rose as much as 0.295 to the highest level in a year, while yields on the cash bonds dropped below 2.9%.

Read: China Stocks Tumble in ‘Panic Selling’ Amid Broad Crackdown

More Positives

Adding to positives for Chinese sovereign bonds is a delay in local government issuance. Only 42% of the total annual quota given has been taken up in the first seven months of the year, Bloomberg calculations show. The sale of new municipal debt in July was only two-thirds that of June and the lowest since April.

Domestic and foreign investors are poised to keep buying. Local banks have bought just 1.8 trillion yuan ($277 billion) of bond assets in the first six months of this year, half that of the same period in 2020, according to data from the central bank. Some government debt will also be added into FTSE Russell’s world bond index come this October, bringing about inflows.

“Funds are slowly buying more bonds after falling short on allocation previously,” said Yang Hao, fixed income analyst at Nanjing Securities Co. “Changing regulations in areas such as real estate may weaken economic growth and credit conditions, boosting appetite for bonds.”

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