Macroscope | Chinese bond momentum remains strong, but don’t expect the yuan rally to last

The onshore rates rally continued in January, thanks to further easing by the People’s Bank of China and strong foreign demand for renminbi bonds – prompted, at least partly, by expectations that China would soon be included in the global fixed-income benchmark.

However, the bigger price action occurred in the credit market, particularly hard-currency (US dollar) Chinese high-yield bonds, where credit spreads have plunged in the past month. A confluence of factors have driven a sharp market reversal from last December, including positive signs in the Sino-US trade talks, a solid rebound in risk sentiment, and a repricing of the Federal Reserve’s policy that undermined US treasury yields and the dollar.

The Chinese macroeconomic backdrop also remained supportive of the bond market. With recent economic data generally undershooting market expectations, the authorities have stepped up policy easing to allay growth concerns. Besides further tax cuts and increased spending on infrastructure, the PBOC has also dialled up monetary stimulus by cutting the reserve requirement ratio, and injecting liquidity via open-market operations and the new targeted medium-term lending facility (TMLF).

The recent introduction of the central bank bills swap (CBS) has opened a new official avenue to support bank lending as it means their perpetual bonds are eligible to tap central bank liquidity. The programme will help boost banks’ tier-1 capital, and in turn allow them to step up their credit supply to the real economy.