Head of Fixed Income Strategy
Summary: Investors crowded the issuance of euro-denominated Chinese government bonds yesterday, pushing yields of 5-year notes below zero. They might be betting that the People's Bank of China will ease the economy further even though it seems on the way to recovery. Indeed, some signals in the corporate space point to troubles ahead. Industrial corporate yields spiked this month signalling more defaults, which might ultimately weigh on the financial system. At the same time selling momentum in Chinese government bonds is picking up. A spike in government bond yields might deteriorate further corporate spreads, and the central bank might not have other option than intervening.
Yesterday, China issued for the first time in a year euro-denominated debt. The offering amounted to €4bn spread across 5-, 10- and 15-year maturities, however, attracted more than €17bn in bids. The new bonds add to the €4bn notes issued last year across 7-, 12- and 20-year maturity.
Interestingly, the 5-year bonds were issued with a negative yield of -0.15%, while the rest of the debt offering carried a positive yield yet, well below 1%.
Besides the Chinese economy's recovery story, there might be another reason behind the high demand in Chinese sovereigns. Indeed, the recent spike of Chinese Industrial corporates' yields shows that there are troubles ahead and that the People’s Bank of China (PBoC) will need to stimulate the economy further to avoid a liquidity squeeze within the corporate bond space.
The sudden spike of corporate bond yields is happening precisely at the same time as yields in China’s 10-year government bonds are rising. To put more pressure on increasing yields, the Relative Strength Index (RSI) shows that the 10-year sovereigns are overbought and that selling momentum is approaching.
It is therefore doubtful that the PBoC will stay watching as a selloff in Chinese sovereigns might correspond with a fast widening of Chinese corporate spreads.
According to the latest annual Financial Stability Report published by the PBoC in November, the non-performing loan (NPL) ratio of 30 sample banks is expected to surge around 5% at the end of this year, 5.5% in 2021 and 6.7% in 2022. These numbers are well above the 1.5% recorded at the end of the first quarter of 2020. Higher NPL numbers don't constitute an issue only for the corporate space, but also for banks. The report shows that a third of the Chinese banks monitored by the PBoC's fail the central bank's stress test. A big part of them needs to raise capital or loss-absorbing debt to fulfil their total loss-absorbing capacity (TLAC).
It explains why just a couple of days ago, the PBoC has injected 800bn yuan in the Medium-term Lending Facilities (MLF) in the credit market. Even though a few days ago, Guoqiang Liu, vice governor of the PBoC, said that the central bank would "sooner or later exit" stimulus policies set in place for the Covid-19 pandemic, it is clear that at the moment it would be risky for the central bank to taper.
The question is whether the PBoC might tighten the economy further in order to avoid rising defaults which would inevitably weigh on the financial sector.
So far, the message of the central bank seems to steer away from a dovish tone. However, the facts are pointing to more stimulus. Bloomberg reported today that the PBoC had injected 70bn yuan into the banking system using 7-day reverse repurchase agreements to increase liquidity in the market. It definitively doesn't look like a central bank that is on the verge of easing the economy, and investors might be right to see an upside Chinese sovereigns.
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As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
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