China’s liquidity rush has bond market looking for catch

Bloomberg

China’s bond investors are being given the chance to ratchet up leverage once again, but they may not want to. Months of scarcity have given way to a mysterious rush of liquidity in China’s financial system, with money-market rates back near levels seen in April. The market has responded accordingly, with bonds rallying in the last two weeks of June. But what could be an invitation to plow back in to debt beaten down by Beijing’s leverage crackdown is being greeted warily by analysts.
Regulators aren’t done yet and the recent bullishness — which saw the gap between AA and AAA rated Chinese corporate yields narrow to the least this year — won’t be welcomed, says Ming Ming, head of fixed income research at Citic Securities Co. in
Beijing. To Guotai Junan Securities Co. analyst Qin Han, the corporate bond rally is “crazy,” and will probably reverse.
“Investment opportunities in bonds are disappearing after these gains,” Qin said from Shanghai. “I’m bearish. Government bonds will likely drop, while the yield gap between AAA company- and lower-rated debt could widen beyond previous highs.”
Traders seem to have a watching brief on the situation. While liquidity is strong, the outlook is unpredictable, according to one trader who isn’t adding leverage at the moment. Another said the market was in wait-and-see mode, given there is no suggestion regulators are pulling back from their deleveraging measures. Both traders asked not to be identified as they aren’t authorized to speak to the media.
Wang Ming, chief operating officer at Shanghai Yaozhi Asset Management LLP, which oversees about 20 billion yuan ($2.9 billion) of fixed-income securities, is cautious about adding debt right now.
“There’s no change in policy direction, the authorities will continue with the deleveraging efforts and the central bank doesn’t seem likely to ease given the economic momentum,” he said. Even so, investing now may be a better idea than toward year-end, which typically brings “more uncertainty and usually tighter liquidity.”
It appears the loose liquidity situation hasn’t escaped the authorities’ attention. The People’s Bank of China started draining more funds from the system toward the end of last month, withdrawing a net 730 billion yuan since June 21.
This probably means the PBOC wants money-market rates to increase from current levels, said Becky Liu, head of China macro strategy at Standard Chartered Plc in Hong Kong.
Ten-year government bond yields — which touched a seven-week low of 3.499 percent in June — could climb to as high as 3.8 percent, she said.
In China, smaller banks use proceeds from negotiable certificates of deposit — short-term debt introduced in 2013 — as a way to invest in the bond market. The cost of these certificates has been rising, with yields on three-month AA+ rated securities surging the most this year.
With the traditional mid-year cash crunch out of the way, Beijing may continue to tighten money-market rates, said Liu Dongliang, a senior analyst at China Merchants Bank Co. in Shenzhen. “Investors shouldn’t be buying bonds with the hope of making a quick profit,” he said.