Tags: China | Inflation | Risk | Leads | Asia | Worst | Bond

China Inflation Risk Leads to Asia's Worst Bond Returns

Thursday, 23 Dec 2010 12:05 AM

 

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China’s bonds are Asia’s worst performers for the second time in four years, reflecting concern the central bank will have to be more aggressive in raising interest rates as it seeks to rein in inflation.

Local-currency government bonds handed investors a return of 1.7 percent this year, the least among HSBC Holdings Plc indexes tracking Asia’s 10 largest economies excluding Japan. Notes in Indonesia, where borrowing costs have stayed at a record low, led regional gains for a second consecutive year in 2010 with a 19 percent advance.

The People’s Bank of China has held off from adding to October’s interest-rate increase, the first since 2007, because further rises may spur capital inflows that stoke inflation, Wu Xiaoling, a former deputy governor, said Dec. 11. Consumer prices jumped 5.1 percent from a year earlier in November, the most in 28 months, and the nation’s top planning agency said last week that prices “urgently” need to be stabilized to safeguard people’s standards of living.

“Surging inflation and sustained robust economic growth may prompt the central bank to raise interest rates five to six times next year,” said Guo Caomin, a bond analyst at Industrial Bank Co. in Shanghai. “We are quite pessimistic about the bond market next year.”

He forecast the yield on benchmark government 10-year bonds will exceed 4.5 percent in 2011, up from yesterday’s closing level of 3.83 percent. The rate jumped 50 basis points, or 0.50 percentage point, since September, headed for its biggest quarterly gain since June 2007. It fell one basis point yesterday.

Bonds, Swaps

China’s central bank will raise interest rates by a percentage point in the next 12 months and the 10-year yield will climb as high as 4.75 percent, according to Societe Generale SA, the second-largest French bank. DBS Group Holdings Ltd., Southeast Asia’s biggest bank, predicts 1.25 percentage points of rate increases and a similar rise in yields.

The one-year interest-rate swap, the fixed cost needed to receive the floating seven-day repurchase rate, has gained 91 basis points to 3.10 percent this quarter, the largest increase in Bloomberg data going back to 2006. The yield on the benchmark two-year bond has jumped 105 basis points to 3.16 percent, the biggest advance since 2008.

“Bonds have been dragged down because of inflation concerns, and talk of an interest-rate hike,” said Robert Reilly, co-head of Asian fixed income at Societe Generale SA in Hong Kong. “The interest rate is coming from very low levels, so the only way for them is to go up.”

Rates Outlook

China’s central bank raised its benchmark one-year lending and deposit rates on Oct. 19 by a quarter of a percentage point to 5.56 percent and 2.5 percent. They are likely to be boosted by about 2 percentage points more in 2011, said Tao Dong, chief economist for Asia excluding Japan at Credit Suisse Group AG in Hong Kong.

Citic Securities Co., China’s biggest listed brokerage, predicts two to three increases in borrowing costs in the next six months will prove sufficient to stem gains in consumer prices, helping support bonds.

“It’s not necessarily going to be another bear-market year for bonds in 2011, even though yields will rise in the first half,” said Hu Hangyu, a debt analyst at Citic Securities in Beijing. The 10-year yield will reach 4.2 percent by the end of June before declining to 3.8 percent in the second half, he forecast.

Loan Growth

Credit growth in the past two years has played a part in deterring Chinese policy makers from raising rates too fast, according to DBS. Outstanding local-currency loans jumped 60 percent in that time to total a record 47.4 trillion yuan ($7.1 trillion) at the end of last month, central bank figures show.

Instead of lifting borrowing costs, China has in recent months focused on restricting lending to help quell inflation. This year’s sixth increase in reserve-requirement ratios for major lenders took effect Dec. 20.

The central bank sold 1 billion yuan of one-year bills at a yield of 2.3437 percent at an auction yesterday, holding the rate unchanged for a sixth week, according to a statement on the monetary authority’s website. The government plans to sell 20 billion yuan of three-month debt on Dec. 24.

Bank of East Asia Ltd. said Dec. 20 its China unit won approval to issue up to 5 billion yuan ($751 million) of local- currency bonds on the country’s interbank market. The Hong Kong- based lender is the first locally incorporated foreign bank in China to obtain approval to issue yuan-denominated financial bonds, Chief Executive Officer David Li said in an e-mailed statement.

Yuan Climbs

The yuan strengthened 0.09 percent to 6.6531 per dollar as of 12:31 p.m. in Shanghai, contributing to a 2.6 percent advance since a currency peg ended in June. Non-deliverable forwards indicate the currency will gain 2.1 percent in the coming 12 months.

Five-year credit-default swaps on Chinese government bonds fell 2 basis points to 69 yesterday, according to CMA prices in New York. 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 debt agreements.

The seven-day repo rate, which measures lending costs between banks, gained 10 basis points today to 4.17 percent, the highest level since June 2008, according to a daily fixing published by the National Interbank Funding Center in Shanghai.

“This year was primarily about managing liquidity and hiking reserve requirements, but interest rates haven’t moved as much; we will see more interest-rate increases next year,” Jens Lauschke, a fixed-income strategist at DBS in Singapore, said in an interview. “For government bonds, that means that the bearish trend is likely to continue in the coming months.”

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