Traders ditch yuan, snap up bonds as lockdown adds to woes

Beijing

CHINA'S slowing growth momentum is taking the wind out of the yuan's rally and lifting sovereign bonds as traders ramp up bets for the central bank to loosen policy further.

The onshore yuan fell to its weakest in a month on Monday (Mar 14) while the 10-year government bond yield dropped as much as 10 basis points since Friday (Mar 11) - the largest two-day decline since July 2021. That was when the People's Bank of China surprised markets by slashing the reserve requirement ratio by 0.5 percentage points for most banks.

Wagers on further policy easing in China are gaining momentum after China locked down the southern city of Shenzhen, home to major technology firms and one of the busiest ports in the nation. Moreover, data on Friday showed the nation's credit expansion unexpectedly slowed in February and a key indicator of home mortgages declined for the first time in at least 15 years.

"China bonds have further room to gain as increasing disruption from Covid-related lockdowns is set to put pressure on consumption and China's economic recovery," said Ming Ming, chief economist at Citic Securities Co.

The war in Ukraine and surging oil prices are other factors that could prompt PBOC action when it announces its policy loan rates on Tuesday, as the nation aims to achieve a growth target of 5.5 per cent for the year.

Hong Kong and China stocks slumped on Monday, led by losses in technology shares, due to risks from Beijing's close relationship with Russia and regulatory concerns. China Securities Journal said in a front-page report on Monday that the central bank may lower interest rates to stabilise growth. Futures contracts on China's 10-year notes closed up 0.6 per cent on Monday, the biggest rise since April 2020. Dollar-offshore yuan one-month risk reversals rose to 0.77 per cent offshore, highest since December 2020, signalling bearish sentiment towards the yuan.

Additional monetary easing could widen China's interest-rate differential with the US, with the Federal Reserve set to lift rates later this week in a bid to tame inflation. The yield spread between China's 10-year bonds and Treasuries of the similar tenor narrowed to 73 basis points, lowest since April 2019.

The PBOC's weaker-than-expected currency fixing on Monday is fanning speculation that authorities may want to prevent yuan strength hurting exports. It set the reference rate for the yuan 150 pips weaker than the average estimate in a Bloomberg survey of analysts and traders. CFETS yuan index, an official gauge of the yuan's strength against 24 trading partners' currencies, rose to a record high of 106.79 as of March 11.

The onshore yuan climbed to its highest since 2018 against the dollar in early March and remains the best performing currency in Asia so far this year.

"The PBOC might be attempting to send out the signal that the yuan is too strong given the recent rally in CFETS index and the easing bias from the National People's Congress," said Ken Cheung, chief Asian FX strategist at Mizuho Bank Ltd.

The central bank set the reference rate 252 pips weaker than the average forecast on Feb 7, the furthest from analyst estimates since 2018. BLOOMBERG