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China bond bulls revived by lowest borrowing cost since 2020

China bond bulls revived by lowest borrowing cost since 2020
The People's Bank of China (PBOC) in Beijing, China, on Monday, 13 December 2021. (Photo: Andrea Verdelli/Bloomberg)

Some China bond investors are betting yields will resume their declines as a liquidity glut pushes short-term borrowing costs to the lowest since December 2020.

The seven-day repo rate, a gauge of the short-term borrowing cost, dropped to 1.54% this week. It’s stayed below the central bank’s operating rate for reverse repo contracts since the start of April, the longest discount streak in two years.

The deviation, once seen as a possible trigger for an engineered liquidity squeeze from the central bank to prevent asset bubbles, isn’t a concern for some investors. They see it as part of the People’s Bank of China’s strategy of maintaining an easy policy stance to support the economy battered by lockdowns to curb the spread of Covid infections.

“We continue to recommend long China bonds and carry trade strategy in May,” said Yang Yewei, analyst at Guosheng Securities Co. “Money market conditions will remain loose with repo rates kept low,” which could push the 10-year yield to near the January low of 2.7%.

China's 7-day repo rate tumbled to lowest since December 2020

China’s benchmark 10-year bond yield has risen more than 10 basis points from a 19-month low hit in January. That’s because the central bank refrained from cutting rates amid the nation’s widening policy gap with the Federal Reserve, which kicked off its rate hike cycle this year.

However, a slew of liquidity support measures from the PBOC including the reserve requirement ratio cut in late April and its profit transfer to the Ministry of Finance have unleashed over 1.3 trillion yuan ($193 billion) of cash into the banking system, making it attractive to borrow cash via repo trades and invest in government debt.

READ: World-Beating Gain for China Bonds Shows Power of PBOC Policy

Repo rates would stay low at least for this month as weak demand for credit has left the cash with “nowhere to go,” said Albert Leung, strategist at Nomura International in Hong Kong. Moreover, the carry trade return, as measured by the spread between 10-year yield and seven-day repo rate, stands near 130 basis points, about the highest in a year.

“The window to long China bonds has already opened even without an actual rate cut, as the central bank will show more tolerance of the lower repo rates,” Li Yishuang, analyst at Cinda Securities Co., wrote in a note.

Fiscal risks

However, bonds could face risks from an increased emphasis on fiscal support to boost the economy.

“In a scenario where more fiscal support is needed, China may consider funding it with special treasury bonds – as it did in 2020,” said Stephen Chiu, Asia FX and rates strategist at Bloomberg Intelligence in Hong Kong.

China’s 10-year bond yields steadied Thursday after rising for the first time in three days in the previous session as data showed factory and consumer prices rose faster than expected in April, damping bets for further PBOC easing.

Chinese Premier Li Keqiang at a State Council Meeting on Wednesday urged officials to use fiscal and monetary policies to stabilize employment and the economy. PBOC Vice Governor Chen Yulu said the central bank has guided loan interest rates to decline.

Bond traders are now watching for possible PBOC action on Monday when 100 billion yuan of policy loans are due. Twelve out of 25 economists and analysts expect a cut to the one-year medium-term lending facilities rate, according to a Bloomberg survey as of Thursday. BM


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