Fears of long-term yuan weakness dampens investors’ appetite for China sovereign bonds

Demand was muted among institutional investors for 10 billion yuan of offshore government bonds despite highest yield to date

PUBLISHED : Friday, 09 December, 2016, 5:17pm
UPDATED : Friday, 09 December, 2016, 11:02pm

The sharp depreciation of the yuan dampened investors’ appetite for Chinese sovereign debt when a batch of yuan-denominated government bonds was issued yesterday in the offshore market.

China’s Ministry of Finance auctioned 10 billion yuan of sovereign bonds to institutional investors on Thursday in Hong Kong and received total bids of 23 billion yuan. This makes the bid-to-cover ratio 2.3 times, significantly lower than the 3.2 times at an auction in June, when near 44.5 billion yuan of bids came in for 14 billion yuan in bonds, according to data from Standard Chartered Bank (Hong Kong).

The muted enthusiasm came despite the fact the bonds carried the highest yield in the primary market since the start of the offshore yuan bond market.

The results suggest investors are concerned about an extended period of offshore yuan liquidity stress
Becky Liu, Standard Chartered

The Ministry of Finance sold a further 2 billion yuan of debt to central banks and monetary authorities on Thursday, but details of the allocation have not been released yet. Another 2 billion yuan tranche was available to retail investors from Friday morning.

Winnie Cheung, assistant general manager of personal banking and wealth management at Bank of China (Hong Kong), feels more optimistic about the sale to retail investors.

“The coupon rate of 3.5 per cent is quite high, and it’s expected to meet retail investors’ demand for high-yield currency investment,” said Cheung.

Notably, the highest demand from institutional investors was for the bonds with the shortest tenor. The 5 billion yuan in three-year notes priced on par with the secondary level of 3.4 per cent before the auction, while there was weaker demand for longer-dated bonds. The five-year to thirty-year tenors priced at a 10 to 40 basis point yield premium over secondary levels.

“The results suggest investors are concerned about an extended period of offshore yuan liquidity stress coming from foreign exchange pressure which is making them reluctant to take on duration risk,” said Becky Liu, head of China macro strategy at Standard Chartered Bank (Hong Kong).

While allocations of the central bank tranche have yet to be announced, Liu expected demand to be heavily skewed towards the three-year tranche as well.

“High hedging costs have further weighed on investor demand amid continuing depreciation concerns,” said Liu.

“The depreciation expectations of the yuan present a double whammy for offshore yuan bonds, where demand for foreign exchange hedging is likely to be higher at a time when offshore yuan cross-currency swap is rising partly because of the bearish outlook for the yuan, said Frances Cheung, head of rates strategy, Asia ex-Japan at Societe Generale.