A four-month rally in offshore yuan bonds has helped issuance almost double this quarter. Further gains may depend on whether China can limit currency losses and defaults.
Offerings of yuan debt outside China jumped to 23.9bn yuan ($3.6bn), from 12.9bn yuan in the first quarter that was the lowest since 2013, data compiled by Bloomberg show. The yield premium for the notes versus onshore peers has narrowed as the yuan rallied in Hong Kong to erase this year’s declines.
While the People’s Bank of China has intervened in the market and clamped down on capital outflows to bolster the currency, strategists are still forecasting losses. Issuance has been less than half maturities in the Dim Sum market for the past two quarters, a symptom of rising corporate debt and slowing expansion in the world’s second-largest economy that is worrying investors.
“The bond market may be still attractive but given varying degrees of concern about depreciation, I would imagine some investors potentially would hedge out some of the currency risk,” said Kenneth Akintewe, Singapore-based senior manager at Aberdeen Asset Management, which oversaw $421bn of assets as of March 31. “We are not massively constructive on the prospect for the currency. We are not as negative as the market is, expecting a significant depreciation.”
Investors need avenues to invest yuan offshore as China seeks to broaden the currency’s global use and it makes its official entry into the International Monetary Fund’s reserves basket in October. Chinese debt also offers relatively attractive yields as major central banks have kept interest rates near zero. Yuan debt traded outside of China returned 3.7% since the end of January, according to the BOCHK Offshore RMB Bond Index.
“More new issuances are likely due to pent-up demand,” said Ken Hu, chief investment officer of Asia-Pacific fixed income at Invesco Hong Kong, which oversees $783.7bn of assets. “After all, the offshore yuan provides higher yields relative to other currencies given negative interest rates in Europe and Japan and the recent interest rate cuts in Australia.”
The offshore China 10-year government bond yield is 3.69%, higher than the 2.94% onshore. That is far higher than the 1.77% in South Korea, 0.84% in Taiwan, 0.18% in Germany and minus 0.102% in Japan.
“Investors are still hungry for yields,” said Frank Huang, head of trading at Sinopac Securities Asia in Hong Kong. “Offshore investors don’t have many choices. Those who need to add China to their portfolios tend to buy offshore bonds rather than onshore notes. They are more transparent and provide attractive yields.”
The currency has rebounded to 6.5662 a dollar in Hong Kong, after touching a five-year low in January, as China’s foreign- exchange reserves gained for two consecutive months. Three-month implied volatility, a gauge of expected price swings, fell to the lowest level since October. The Ministry of Finance said last week it will soon issue yuan bonds in London, just as the average yield on offshore renminbi debt declined to 4.69% this month, the lowest since November, a Deutsche Bank AG- compiled index shows.
“The relative stability of the yuan on a trade-weighted basis and stabilizing foreign-exchange reserves have reduced the fears of sharp one-off devaluations,” said Neeraj Seth, head of Asian credit at BlackRock, which had $4.7tn assets under management as of March. “This has led to improvements in funding conditions in the offshore renminbi market.”
The performance of dim sum bonds has diverged with the offshore yuan since March, showing investor demand is increasing even as the currency’s weakness risks cutting into returns. The yuan in Hong Kong will decline 1.4% to 6.66 a dollar this year and slide a further 1.8% to 6.78 in 2017, according to median estimates in a Bloomberg survey. The PBoC lowered the yuan’s daily reference rate to 6.5693 per dollar last week, the weakest since March 2011.
The upcoming interest-rate decision by the Federal Reserve next month will test investors’ confidence, as the Bloomberg Dollar Spot Index rallies. The odds of an increase in June jumped to 32% from 4% at the beginning of last week.
Data on China’s industrial production and retail sales missed estimates for April, making it harder for local companies to repay debt. At least 10 issuers have reneged on onshore bond obligations this year and companies pulled at least 175bn yuan of domestic note offerings this quarter. Offshore, sales are still equivalent to only 40% of the notes maturing in the first half.
“There could be some more volatility from the potential interest-rate increase in the US in June as well as any potential volatility arising from defaults in corporate markets,” said Manu George, a Singapore-based Asian fixed-income investment director at Schroder Investment Management, which oversees $440bn globally. “Those type of things will obviously have an impact on returns.”