UBS Asset says China volatility spells continued bond boost

[SHANGHAI] UBS Asset Management said turmoil in China's stock market will help extend a bull run in the nation's bonds, as investors channel more funds into debt securities to avoid equity volatility.

The yield premium on the country's top-rated corporate notes over similar-maturity government bonds has fallen eight basis points this week, set for its biggest weekly decline in two months. China's CSI 300 Index of shares has extended this year's drop to 12 per cent, plunging 7.2 per cent Thursday before trading was halted by automatic circuit breakers. The onshore yuan weakened 0.6 per cent versus the dollar to a five-year low.

The stock slump "just shows that sentiment remains fragile - in China and globally - which is likely still supportive for bonds, as we have seen," said Ashley Perrott, the Singapore- based head of Asian fixed-income at UBS Asset Management, which oversaw US$652 billion at the end of September. "China onshore bonds will continue to benefit from the equity caution - a trend seen in the second half of last year and likely to continue for a while yet."

Rising demand for fixed-income securities would help Chinese companies raise money while they are struggling with debt repayment amid the worst slowdown in a quarter century. Chinese corporate defaults will likely spread in 2016, financial companies surveyed by Bloomberg said late last year, after at least seven companies reneged on bond obligations in 2015.

The overnight repurchase rate, a gauge of interbank funding availability, fell one basis point to 1.95 per cent as of 11:51 am in Shanghai, according to a weighted average from the National Interbank Funding Center, after dropping as much as five basis points earlier. The rate has declined 17 basis points this year from 2.12 per cent on Dec 31, the highest since April, showing that borrowing costs are falling.

"If the stock slump continues, more funds will flow into the bond market, which will lead to a decline in borrowing costs," said Ji Weijie, a bond analyst at China Securities Co in Beijing. "The funds would prefer bonds with better liquidity, such as government or policy bank bonds."

Some investors said not all about the current turmoil is positive for debt securities, as the yuan's fall could affect the onshore cash supply. The Chinese currency has dropped about 1.4 per cent against the dollar this year. Outflows of capital from China in the most recent three months for which figures are available amounted to greater than the size of the Greek economy, according to data compiled by Bloomberg.

"If the yuan declines a lot against the dollar, depreciation will add pressure on liquidity, which won't be good for the bond market," said Qiu Xinhong, a bond fund manager in Shenzhen at First State Cinda Fund Management Co. "Even though the central bank can inject cash to make up for the capital outflows, it can't inject without limit."

BLOOMBERG