China Government Bonds: Unlikely laggards

CGBs yield a massive 130bps over US Treasury and CGB curve still offers decent roll down. In a world where positive yields and steep curves get increasingly scarce by the day, CGBs look compelling.
Duncan Tan08 Jul 2019
  • In 1H, expectations of CGB outperformance did not materialize
  • Some positive economic data and the takeover of Baoshang Bank were behind the poor showing
  • Having lagged in the global bond rally, CGBs now look quite cheap and offer decent roll down
  • PBOC turning more accommodative. Bank funding rates are coming down and could support CGBs
  • Implication for investors – stay bullish on CGB and expect better performance in 2H
Photo credit: AFP Photo

CGB performance was poor in 1H

The underperformance of China Government Bonds (CGB) in the first half of 2019 has caught investors by surprise (many had CGB as conviction ideas). Many held the view that the People's Bank of China (PBOC) has the will, the room, and the tools to ease to support economic activity. In addition, CGBs will enjoy a boost in foreign demand from inclusion into the Bloomberg Barclays Global Aggregate Index. But the CGB’s underperformed.

When we compare movements in CGB vs US Treasury yields and look at the timeline of events, we think the underperformance was largely due to two time periods. In April, China's economic data was picking up, leading to greater confidence that the economy had bottomed. Stocks surged. PBOC officials subsequently gave signals that they were going to dial back on stimulus. Over the month of April, 10Y CGB yields jumped 34bps vs UST's 10bps. In late-May, PBOC and China Banking and Insurance Regulatory Commission assumed control of Inner-Mongolia-based Baoshang Bank, citing serious credit risks. The event spurned concerns over the credibility of smaller banks and non-bank financial institutions. Many of these smaller institutions were holders of CGBs and used CGBs as collateral to borrow. They had to sell when their funding markets contracted and borrowing costs surged. In the last week of May, 10Y CGB yields fell 2bps vs UST's 19bps.

CGB are quite cheap now

Ytd, we have seen a strong rally in global fixed income on the back of expectations that global interest rates would be lower for longer. Many sovereign bonds have gotten quite rich and are now pricing in substantial monetary easing and rather downbeat economic scenarios. For investors late to the rally, the bar for price appreciation has risen to quite high levels (markets would need to assume recession or sharp growth slowdown for bond prices to rally further). In contrast, CGB yields have lagged the rally (10Y tenor unchanged year-to-date), making it relatively cheap. 10Y CGBs now yield a massive 130bps over US Treasury and the CGB curve still offers decent roll down. In a world where positive yields and steep curves get increasingly scarce by the day, CGBs look compelling.

Interbank liquidity conditions are a key factor in the outlook for CGBs (ownership is dominated by domestic banks). Since April, PBOC's liquidity interventions in the banking system has clearly turned more accommodative. Consequently, bank funding rates are coming down and could drive CGB yields lower in the months ahead. Furthermore, with economic momentum still weak, PBOC could make further reductions to the required reserve ratios, freeing up funds that could go to purchasing CGBs.

To read the full report, click here to Download the PDF.

Duncan Tan

FX and Rates Strategist - Asean

The information herein is published by DBS Bank Ltd and PT Bank DBS Indonesia (collectively, the “DBS Group”). It is based on information obtained from sources believed to be reliable, but the Group does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. Any recommendation contained herein does not have regard to the specific investment objectives, financial situation & the particular needs of any specific addressee. The information herein is published for the information of addressees only & is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Group, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Group or any other person has been advised of the possibility thereof. The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Group & its associates, their directors, officers and/or employees may have positions or other interests in, & may effect transactions in securities mentioned herein & may also perform or seek to perform broking, investment banking & other banking or finan­cial services for these companies. The information herein is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. Sources for all charts & tables are CEIC & Bloomberg unless otherwise specified.

DBS Bank Ltd., 12 Marina Blvd, Marina Bay Financial Center Tower 3, Singapore 018982. Tel: 65-6878-8888. Company Registration No. 196800306E.

PT Bank DBS Indonesia, DBS Bank Tower, 33rd floor, Ciputra World 1, Jalan Prof. Dr. Satrio Kav 3-5, Jakarta, 12940, Indonesia. Tel: 62-21-2988-4000. Company Registration No.