China cash crunch a boon for foreigners snapping up bank bonds
AMID a foreign exodus from China’s bond market a hardy few are choosing to stick it out, leveraging attractive rates for swapping US dollars into a lucrative trading strategy in short-term bank debt.
Their target is negotiable certificates of deposits (NCDs), short-term bonds sold by banks with maturities of up to a year and the kicker is the premium for overseas investors get swapping US currency for yuan in China’s onshore market. A trader who does this and ploughs her yuan into NCDs can obtain a return of around 100 basis points above that of Treasuries, according to calculations by Bloomberg.
The trade has proved so attractive that foreign investor NCD holdings grew 80 per cent in the first 10 months of 2023 to a record high at 290 billion yuan (S$55.3 billion). That compares with a 9 per cent drop in their sovereign bond holdings this year, extending a record withdrawal in 2022.
One of the key factors helping fuel demand for the NCD-swap trade is a shortage of yuan in the financial system which has pushed up China’s short-term interest rates, increasing the potential return from the strategy.
“After the recent onshore yuan funding squeeze, one-year Chinese government bonds and NCDs offer good carry pick-up over onshore foreign-exchange swaps and cross-currency swaps,” said Ju Wang, head of greater China FX & rates strategy at BNP Paribas.
Yields on one-year NCDs from Chinese banks with AAA credit ratings have risen to 2.64 per cent, close to the highest since March, after an increase in government bond supply crowded out local demand for these securities. Overseas buyers then get a sweetener from Chinese traders paying to swap their yuan for US dollars, bringing their expected yield to about 6 per cent, according to data compiled by Bloomberg. That’s an attractive proposition given equivalent T-bills have fallen back below 5 per cent.
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In November, some foreign banks and overseas units of Chinese banks swapped US or Hong Kong dollars into yuan and bought NCDs, according to traders who asked not to be named as they are not authorised to speak publicly. The offshore institutions have been more proactive in considering Chinese onshore debt following the recent recovery in the yuan, they said.
The NCD purchases mark a rare bright spot in foreign appetite for China assets which has slumped thanks to concern over growth and increased tensions with the US. Chinese stocks are trading at their biggest discount to emerging-market peers in a quarter of a century and the outlook for its bonds was recently cut by Moody’s Investors Service.
Goldman Sachs is also among the global banks that sees value in China’s short-term bonds on a hedged basis. For US dollar-funded investors, currency-hedged short-term bonds, including NCDs have become more attractive “given sizable spreads over US Treasury yields”, strategists including Xinquan Chen wrote in a note this month.
Still, the attraction of NCDs for this type of carry trade is vulnerable to central bank moves in the money market, according to Xing Zhaopeng, senior strategist at Australia & New Zealand Banking Group. The foreign buyers are likely “fast money” and could turn away when the yield pick-up shrinks once the People’s Bank of China acts more decisively to ease funding stress, he said. BLOOMBERG
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