Credit/FX/rates: Index-inclusion tailwind for Chinese govvies

Neel Gopalakrishnan, Credit Strategist, DBS Bank and Eugene Leow, Rates Strategist, DBS Bank

Overnight, reconciliatory remarks from US and China led to a bounce in risk sentiment even as reports indicated that trade talks between the two sides have broken down. In any case, trade tensions are likely to linger for some time yet. Against this backdrop, China government bonds have performed very well over the past few months even as there have been some volatility in the USD/CNH. 10Y CNgov yields have fallen to 3.73%, from a peak of 4.04% in late November amid benign macro factors. Easing short-term onshore interest rates (7D repo and the 3M Shibor) also helped.

Sentiment on govvies is bullish as the market focuses on structural flows that will take place as China gets added to the Bloomberg Barclays Global Aggregate Index (weight approximately 5% of the index). This will be phased in over 20 months starting April 2019. Assuming that USD200bn of funds flow to Chinese bonds, this figure represents about 5% of current government securities outstanding. Foreign ownership will clearly be much higher compared to about 2% that foreign institutions currently hold.

While these flows are undeniably positive for Chinese bonds, it must be noted that foreign investors are unlikely to be the swing factor for yield trajectories for quite a while. In Asia, foreign ownership in govvies tend to be much higher. For example, foreign investors own close to 40% of Indonesia government debt and as a result, foreign buying or selling became the single largest explanatory factor driving yields over the past few years. Comparatively, even if foreigners own 5-6% of Chinese papers over the three years, these holdings will be small relative to commercial banks and their wealth management arms.

Activity in Asian credit markets regained some momentum this week though primary market activity was largely from North Asian high grade issuers. Sentiment was slightly better as trade-war related concerns eased although we believe market participants will stay cautious given recent volatility. In terms of news flow, emerging markets outside Asia were in the spotlight. Moody's changed the outlook on Brazil's Ba2 rating to stable from negative. Moody's said that the change was driven by its expectation that "the next administration will pass the fiscal reforms needed to stabilize debt metrics over the medium term" and that "higher-than-expected short and medium-term growth prospects will support fiscal consolidation efforts". While positive for sentiment, the outlook change is unlikely to have much market impact given that both S&P and Fitch rate Brazil at BB- (that is, one notch lower relative to Moody's).

Out of the Middle East, Qatar (Aa3/AA-/AA-) is meeting bond investors to issue a three tranche (5Y,10Y and 30Y) USD bond issue. This is Qatar's first deal since May 2016 and obviously first since four GCC countries including Saudi Arabia and the UAE cut off diplomatic ties with Qatar last June. A successful bond issue will alleviate investor concerns over Qatar's funding ability following last year's diplomatic issues, although the country's large external assets are supportive of its liquidity position. Meanwhile, also out of the GCC, Saudi Arabia (A1/A-/A+) priced USD 11 bn of bonds across 7Y, 12Y and 31Y tenors at yields of around 4.15%, 4.56% and 5.14%.

Source : Equity Bulls

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