With the market expecting China's central bank to continue to cut interest rates and other central banks around the world to implement tightening policies, Chinese sovereign bonds are expected to extend their gains, and short-term bonds are outperforming expectations.
China's central bank on Monday decided to cut the Medium-Term Lending Facility (MLF) by 10 basis points (the first policy rate cut since April 2020) and cut the 7-day reverse repo rate. Investors are already poised for the central bank to cut rates further in the coming months.
Source: Bloomberg
At a time when the Fed is shifting its focus to curbing inflation, China is trying to support economic growth. Liu Guoqiang, deputy governor of the Chinese Bank, reiterated that view on Tuesday, saying the central bank would "open the monetary policy toolbox a little wider to avoid a credit collapse."
CiCC analysts wrote in a note: "China's interest rate market has not yet fully digested the weakness of economic fundamentals, the disruption caused by the epidemic, and the prospect of further interest rate cuts, and there is room for yields to fall."
Further rate cuts are likely in the second quarter, with benchmark yields falling
The chief economist of CITIC Securities expects the yield on the 10-year treasury note to slip to 2.6 percent in the medium term, while the People's Bank of China will maintain its easing leaning. He hinted at another rate cut or two, possibly in March and June. Standard Chartered Bank, BNP Paribas, Nomura Holdings and AF GROUP all expect policy rates to fall further by the end of the second quarter.
Sovereign bond yields have been on a downward trend since mid-December last year, following the PBOC's shift to more aggressive easing. This week, as the 10-year benchmark rate slipped to around 2.74 percent, the rate of decline accelerated, with domestic companies, including GF Securities and Guosheng Securities, expecting yields to approach 2.6 percent.
Analysts believe that China's benchmark bond yield has room to fall to 2.6% / Source: Bloomberg
The bond yield curve is steeper and the front end is more attractive
If history is taken as a guide, China's sovereign bond yield curve should become steep as central banks ease policy, making the front end attractive to investors. Traders have pushed spreads between 10- and 3-year Chinese treasuries above 40 basis points, the highest level since May last year.
With the easing of china's central bank, China's sovereign bond yield curve has steepened / Source: Bloomberg
Nomura Securities' Asia Emerging Markets Strategist in Hong Kong said: "The short-term gains from the PBOC's interest rate cut will generate more expectations for further easing." He is less optimistic about the 10-year Yield, but could rebound in the second quarter if there are more signs of growth and credit bottoming.
The 7-day repo rate will fall simultaneously, or use the 14-day reverse repo
Xu Zhang, an analyst at Everbright Securities, said the seven-day repo rate, a measure of the cost of interbank lending and leveraged financing, typically fluctuates in tandem with the central bank's own seven-day reverse repo rate, so it could fall by about 10 basis points.
Chinese Min Min Bank's interest rate cut may reduce the cost of interbank repurchase financing / Source: Bloomberg
Chinese Min Min Bank has shown a willingness to inject more liquidity into the banking system before the Spring Festival, as highlighted by this week's consecutive daily net capital injections. To ensure that the banking system has sufficient cash reserves to meet the needs of the holiday week beginning Jan. 31, a 14-day reverse repurchase agreement may be invoked.
A slowdown in China's treasury yield advantage will ease the pressure on the renminbi to appreciate
The spread between 10-year Chinese sovereign debt and the same-maturity U.S. Treasury has narrowed to about 85 basis points, the lowest level since 2019. And as speculation about the Fed's March rate hike increases, the pace of sell-off on U.S. Treasuries will accelerate, and yield premiums on three-year Treasuries will fall to their lowest level since May 2019.
The 3-year and 10-year spreads between China and the United States are both below 100 basis points/ Image source: Bloomberg
The decline in China's yield advantage over the United States could slow foreign purchases of Chinese bonds, thereby undermining the incentive for the renminbi to appreciate.