China's delay in cutting rates further turns off bond investors

[SHANGHAI] China's reluctance to aggressively ease its monetary policy is putting a global bond fund on the defensive.

AllianceBernstein Holding slashed its duration risk on China bonds to benchmark weight after being overweight for 18 months. "It's time to take a breather," said Brad Gibson, co-head of Asia Pacific fixed income. The People's Bank of China might be trying to avoid another rate cut, "so lower yields from here will be hard to see," he said.

The pivot underscores how investors are calling time on one of the best bond strategies in the past year, where Chinese sovereign debt stood out as a haven in a global selloff.

The bet that the PBOC is embarking on an easing cycle is done because Beijing will probably drive further economic recovery through fiscal spending, which will mean more debt supply, Gibson said.

"That additional supply would be bad for bonds in the near-term," the Hong Kong-based money manager said in an interview, adding that there's possibility of another cut in banks' reserve-requirement ratio.

Others have also said it's time to pull back from Chinese bonds, with Pacific Investment Management worried about their narrowing yield premium over Treasuries. Citigroup scaled back its recommendation on China bonds to neutral while Societe Generale and Barclays forecast further moderation in foreign purchases.

Global demand for Chinese debt cooled off in January as funds dumped policy bank notes, after boosting allocations following the inclusion of the nation's debt in a global bond index in October.

China's benchmark 10-year yield has risen 13 basis points from a 20-month low of 2.68 per cent in late January as moves like the reduction in mortgage downpayments for homebuyers fanned speculation that the PBOC may hold back its firepower. The Chinese currency is also getting a boost amid these bets, with both the onshore and offshore yuan trading at their strongest levels since 2018.

Meanwhile, concern over more fiscal spending is gaining traction in the run-up to the National People's Congress starting early March as traders wait to see how the government aims to achieve its growth target.

Gibson's other comments on China bonds: "If consumption and retail stay soft, the PBOC will be forced to ease rates to achieve growth targets. But if we're right, we could see short term weakness in the bond market on the back of fiscal supply and a recognition that we might not see more rate cuts."

"The yield curve has begun to steepen and the middle part, which could be most affected by fiscal stimulus and supply will waver a bit. That trend can continue for a while, but we're not scared of it we'd welcome it." "China will bend to its own tune and potentially become the dominant risk-free rate in Asia. I wonder if in five years I'll be looking at a Thai bond spread to China bonds instead of the spread to U.S. Treasuries." "If we were worried about a systemic event and what it might do to the dollar and Treasuries, I don't mind owning the renminbi and Chinese government bonds in such an environment."

Still, Western Asset Management and Fidelity International remain optimistic on continued foreign demand for Chinese debt given that global funds hold just around 11 per cent of the world's second-biggest bond market.

Gibson, however, would only consider re-engaging in China's 10-year bonds at a yield of 3 per cent as that would provide "a comfortable real yield buffer with inflation around 2 per cent." The 10-year yield fell four basis points to 2.81 per cent on Wednesday. BLOOMBERG