13 November 2017, 15:44 GMT
After a busy October in China with the mid-Autumn festival, Golden Week, followed by the 19th China Party Congress (CPC), we were hoping for some respite. However, towards the end of the month, the onshore market kept us on our toes with 10-year Chinese government bonds yields surging to a 3-year high. The PBoC swiftly injected liquidity into the market and was the first time they started longer-term refinancing operations to help ease conditions.
Chart 1: China's 10-year government bond yields surged to a three-year high
The sell-off was largely fear driven but its magnitude was escalated by the semi-efficient nature of the Chinese domestic market. Onshore trading and positioning has an extremely short-term trading bias - we are talking days or even hours. Most domestic market participants use Treasury futures as the leading market indicator (from time to time the yield curve is inverted due to supply/demand imbalances). People who were fearful of a market collapse rushed to hedge their cash bond positions which resulted in a further leg down for the cash bonds, escalating the situation. Furthermore, indication of higher quality, yet slower GDP growth due to the evolving regulatory environment was one of the major take-aways from the CPC. This, coupled with the potential for global rate hikes globally, concerned some market participants.
During this event, the PBoC’s stance was to “massage the interbank liquidity condition”. The liquidity injection post the yield spike improved conditions in the interbank market, which was a contrast to the tight liquidity we have seen since the beginning of October.
Offshore Chinese yields have not reacted as much as they are more related to renminbi moves against the dollar and sentiment here is still supportive. Unlike the last sell-off in December 2016, the recent moves were concentrated on rates and did not extended to credits.
In our China portfolios, we moved from short duration to neutral upon the recent rate sell off, and will gradually shift longer duration when opportunity arises. In our view, there are opportunities to be longer duration in medium term as the market efficiencies improve. However, it should be remembered that China is a semi- efficient market with a new breed of market participants with limited experiences.
Like it or not, this is the current state of the China bond market. A decade ago, the Chinese domestic bond market barely existed. China has since evolved into one of the major economies in the world with contribution to global GDP of over 30%. The development of Chinese onshore market and its structural improvement have increased China’s significance in the Asian high yield market both in terms of supply and demand. Plenty of risks and opportunities will arise as the Chinese market continues to evolve and develops into a more efficient and sophisticated market.
With Fidelity’s on-the-ground investment capabilities in Shanghai and our focus on idiosyncratic risks, we look to exploit market inefficiencies and potential opportunities as they arise.
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