Bloomberg News

Bond Yields Hit 11-Month Low on Yuan Gain, Europe: China Credit

October 12, 2011

Oct. 12 (Bloomberg) -- China’s government bond yields are trading at an 11-month low, signaling concern Europe’s sovereign debt crisis is worsening and a stronger yuan will further slow the world’s second-largest economy.

The yields on 10-year bonds dropped 27 basis points in the past month to 3.78 percent, the lowest since November 2010, as those for similar-maturity debt in the U.S., Russia and India climbed. Sovereign assets are being favored over corporate securities, with investors demanding a record 236 basis points more to hold Chinese company debt over government notes.

Wing Kwai Trading Co., which makes sandals targeted at the U.S. market, and J-Star Manufacturing Co., a glassware maker, say a combination of cooling global demand, rising wage costs and the yuan’s 3.6 percent advance in 2011 are hurting orders. A report due tomorrow will probably show gains in overseas sales slowed, while data due on Oct. 18 may indicate the weakest economic growth since the third quarter of 2009.

“Investors are looking for a safe haven and are putting all their money into the bond market,” said Frances Cheung, a senior strategist at Credit Agricole CIB in Hong Kong. “Investors have become very bearish, too bearish, about China’s economy and are pricing in a hard landing.”

China’s government issued statements today protesting against the U.S. Senate passing a bill aimed at forcing gains in the yuan. The central bank said that the currency is at a “reasonable” level. The yuan traded at 6.3821 per dollar as of 1:11 p.m., slipping from a 17-year high reached yesterday.

Bond Rally

Yields on 10-year yuan-denominated bonds dropped one basis point, or 0.01 percentage point, to 3.762 percent yesterday. The decline over the past month compared with a 25 basis-point jump for similar-maturity Treasuries, an 83 basis-point increase for Russian debt and a 41 basis-point gain in yields on Indian notes. The finance ministry sold 30 billion yuan ($4.7 billion) of seven-year bonds at an average yield of 3.65 percent today.

The Ministry of Railways sold seven-year bonds at a lower coupon than its last auction of five-year debt, as a tax cut on interest income lured investors back after a high-speed train accident hurt confidence. The rail operator sold 10 billion yuan of seven-year notes at 5.59 percent today, 34 basis points lower than the rate on the five-year debt sold on Sept. 7.

The world’s biggest exporting nation faces the risk of its two largest markets, the European Union and the U.S., falling back into recession. The euro region’s economy expanded 1.6 percent in the second quarter, the slowest pace since the first three months of 2010.

Exports rose 20.5 percent in September from a year earlier, down from 24.5 percent in August, according to the median estimate in a Bloomberg News survey of economists. Imports may have gained 24.2 percent from 30.2 percent. The trade surplus dropped to $16.3 billion last month from $17.8 billion the previous month, a separate survey indicated.

Best of BRICs

China’s gross domestic product climbed 9.3 percent in the third quarter from a year earlier, according to the median estimate in a Bloomberg News survey of 20 economists. That would be the third straight quarter of slowing growth.

The yuan added 1.2 percent in the third quarter, while Brazil’s real slumped 17 percent, Russia’s ruble dropped 13 percent and India’s rupee weakened 8.7 percent. The JPMorgan Nominal Effective Exchange Rate, a trade-weighted index for the yuan, gained 4.7 percent in September, the most since December 1997, increasing the cost of goods made in China.

Falling Demand

“Demand for our products has been falling because of the economic outlook,” said David Huang, owner of Wing Kwai, a Chaozhou, eastern China-based footwear exporter. “The yuan keeps rising and workers are asking for higher and higher wages,” he said.

Monetary tightening is also cooling the economy, after bank reserve requirements were raised to a record and interest rates were increased five times since mid-October.

“China’s central bank has been very aggressive in its monetary tightening to rein in inflationary pressure and what we’re seeing is a government-engineered slowdown of the economy,” said Delphine Arrighi, a senior rates strategist at Standard Chartered Plc in Hong Kong. She estimates the yield on the 10-year bonds will drop to 3.6 percent by the end of the year. At the end of 2012, the yield may be 3.7 percent, she said.

‘Sharp Deceleration’

Economic growth could fall to about 7.7 percent in the first quarter of next year as faltering expansion in the U.S. and Europe weakens export demand, estimates Wang Tao, a Hong Kong-based economist for UBS AG. “A sharp deceleration in external demand is on the way,” she said.

Ding Weimin, general manager of Taizhou, Zhejiang province- based J-Star Manufacturing, said he also faces rising wages and a stronger currency.

“Originally the problem was less serious as all other Asian currencies were rising even more than the yuan,” Ding said. “But that’s not the case anymore.”

The yuan’s climb this year against the dollar compares with declines of more than 4 percent for South Korea’s won and Taiwan’s dollar.

China’s exports fell for 13 straight months during the last global financial crisis, contributing to the slowest annual economic expansion in seven years in 2009. Another world recession could see overseas sales decline by 10 percent to 12 percent, with net exports subtracting about 2 1/4 percentage points from growth, according to Wang of UBS.

Share Purchases

Investors have focused on risks for the Chinese economy including a slowdown in the real-estate market and the possibility that bad loans will increase.

State-run Central Huijin Investment Ltd. started buying shares in the four biggest Chinese lenders, Industrial & Commercial Bank of China Ltd., China Construction Bank Corp., Agricultural Bank of China Ltd. and Bank of China Ltd., yesterday after the MSCI China Financials Index dropped 43 percent in 2011 through Oct. 4.

Jim Chanos, the founder of New York-based hedge fund Kynikos Associates, said in an interview with Bloomberg Television yesterday that he remained bearish on Chinese bank stocks. Standard & Poor’s estimates that as much as 30 percent of China’s lending to local governments may go sour.

Credit-default swaps insuring China’s bank debt fell yesterday. The cost of protecting Bank of China debt against non-payment for five years declined 13.5 basis points to 297.5 basis points as of 4:17 p.m. in Hong Kong, according to data provider CMA. Contracts on China Development Bank Corp.’s debt fell 8.2 to 330.1.

‘Trade War’

The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.

“The outlook for external demand and the property sector are the key downside risks to the near-term outlook,” said Brian Jackson, a Hong Kong-based strategist with Royal Bank of Canada. “The risks look manageable for now.”

The yuan will rise to 6.25 per dollar by the end of this year and 5.85 by the end of 2012, Jackson said. Analysts at London-based Capital Economics Ltd. expect the currency to strengthen to 6.25 per dollar by year-end and 6 by the end of 2012.

“The yuan may maintain its current pace of appreciation due to external pressure as currency is often used by some countries as an excuse for a trade war,” said Wang Jun, a researcher with the government-backed China Center for International Economic Exchanges in Beijing.

Increased trade with other emerging economies has helped Chinese exporters reduce their reliance on the U.S. and European markets, said Wang. Growth in overseas sales could slump to 8 percent or 9 percent by early 2012 should their economies enter a recession, he said.

--Nerys Avery. With assistance from Victoria Ruan in Beijing and Andrea Wong in Taipei. Editors: Paul Panckhurst, Emma O’Brien

To contact the reporter on this story: Nerys Avery in Beijing at navery2@bloomberg.net

To contact the editor responsible for this story: Paul Panckhurst at ppanckhurst@bloomberg.net


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