China’s yield premium over US fades as more exits seen

(Bloomberg) — China’s yield advantage over Treasuries disappeared for the first time in more than a decade, paving the way for more capital outflows following the Asian nation’s recent record exodus.

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The yield spread between Chinese 10-year bonds and comparable Treasuries turned negative on Monday, the first time it has done so since June 2010. The move has been taking place for weeks as the Federal Reserve begins an aggressive cycle. rate hike as China looks set to ease further.

Global funds have already sold almost 90 billion yuan ($14 billion) of Chinese sovereign debt in the past two months as the yield premium faded. Pacific Investment Management Co. and AllianceBernstein Holding LP were among those who soured on the bonds.

“If inflation risks continue to play out in the US, it is easy to see short-term US yields outperforming Chinese government bonds, especially on renewed growth risks from lockdowns. China,” said Ashish Agrawal, a strategist at Singapore-based Barclays Bank Plc. .

There is a growing expectation that the People’s Bank of China would need to ease further, with a key lending rate in the spotlight this week, as the economy struggles with widening Covid lockdowns. China’s 10-year bond premium has fallen from more than 100 basis points since the start of the year as money markets price in the strongest pace of Fed tightening in nearly three decades.

Exits from China’s debt markets will continue in the near term, according to Xing Zhaopeng, senior China strategist at Australia and New Zealand Banking Group. He expects US yields to have a 15 basis point lead over Chinese peers next year, with 10-year Treasuries at 3%.

China’s 10-year yield rose two basis points to 2.78%. That’s after data showed credit expanded at a faster-than-expected pace and factory-gate prices rose more-than-expected in March. That is unlikely to stop the PBOC from relaxing, however, as China faces its worst covid outbreak in two years and a prolonged lockdown in Shanghai threatens to undermine the nation’s 5.5% growth target this year. .

Some analysts are sticking with their bullish bets on Chinese assets given that China’s rate of inflation is still below that of the US “China’s real yield remains higher than the US’s, which which indicates that the yuan is likely to remain basically stable for now,” said Qi Gao, currency strategist at Scotiabank in Singapore.

foreign departures

Global funds’ holdings of Chinese sovereign bonds fell to 10.8% last month from 11.1% in February. Goldman Sachs Group Inc. earlier cut its bond inflow forecast for China to $100 billion this year, from as much as $140 billion.

Outflows from China’s domestic markets, combined with declining yield premiums, cast doubt on the strength of the yuan. The onshore yuan fell 0.1% to 6.3696 per dollar on Monday, but remains Asia’s top-performing currency this year on the back of the nation’s strong current account surplus.

“Treasuries have been pricing in a multitude of gains,” said Edmund Goh, head of China fixed income at Shanghai-based abrdn Plc. “Investors are concerned about the valuation of the yuan if China no longer has a higher interest rate advantage.”

However, Barclays’ Agrawal does not see the record bond withdrawal as having an adverse impact on the currency. Portfolio outflows have been driven mainly by active managers reducing duration risk, she said, adding that China’s current account surplus may offset these headwinds.

“Both economies are at very different stages of the cycle, nominal rates have converged, but real rates remain attractive as far as China is concerned,” Agrawal said.

(Updates throughout.)

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