China govvies have room to rally; India rates and fiscal slide

We are cautiously optimistic on China govvies. Long-end India govvies take a hit from fiscal worries.
Eugene Leow, Radhika Rao13 Nov 2019
    Photo credit: AFP Photo

    Rates: Cautious optimism on China govvies

    Policy easing by the People’s Bank of China (PBoC) will be supportive of govvies and rates in 2020. Bond investors were largely disappointed with the returns in 2019 when the PBoC took a calibrated approach to easing than expected. In total return terms, China govvies clearly lagged peers. The 1Y MLF rate was cut by just 5bps this year, compared to 75bps worth of Fed cuts. The difference is even more stark for the longer tenors. 10Y China yields are down by less than 10bps since end-2018. Comparatively, 10Y US yields are still down by around 75bps over the same period.

    In 2020, we think that the PBoC can deliver another 5-10bps of cuts, playing catchup to the rest of the world. as growth and inflation ease, we see 10Y government bond yields drifting towards 3% in the coming few quarters. Downside below 3% does not appear likely at this point. There are several factors working against a large rally in China rates. Firstly, China’s diminished current account surplus is no longer as supportive of lower rates. Secondly, we think the PBoC may still be worried about high leverage and excessive weakness in the RMB. Thirdly, an uplift in DM rates could put modest upward pressures on China rates.

    India rates: Growth worries to lift INR 10Y yields

    This week’s dataflow reinforces the near-term divergence in growth and inflation – slow growth, but above-target inflation due to supply disruptions. On the first, Sept industrial production declined -4.3% YoY, worse than consensus but close to our forecast of -4.5% YoY. Most lead indicators tracked by the DBS GDP Nowcast model points to a sub-5% growth in 2QFY20 vs 5% in 1Q (see here). Oct CPI inflation, due today, likely quickened to 4.5% YoY, past the 4% target. A surge in food costs i.e. vegetables, cereals and perishables are expected to have lifted food (and bevs) inflation up 6.5% vs 4.7% month before, while core eased below 4%. Even as inflation runs above RBI’s forecasts, the weaker run-rate for growth will deter the MPC from pulling the brakes on its rate cutting cycle. We expect the 2QFY20 GDP report, which will be released before the early-December rate review to prod the MPC to ease rates by 25bps next month.

    On the rates front, 10Y bond yield (generic) rose to a post-auction high (for the new paper) of 6.56% and might grind higher as expectations of more fiscal stimulus to stave growth risks gain traction. 2Y yield is off lows as markets price in lesser cuts following firm inflation prints, nonethelessleaving the 2Y/10Y term premium at a wide100bps, underpinning our steepening bias. FPIs are constructive on the INR paper with net inflows in Nov, albeit rupee weakness redux could hurt investors’ appetite. Moody’s outlook downgrade also added to weak sentiments.

    Eugene Leow

    Rates Strategist - G3 & Asia

    Radhika Rao

    Economist – India, Thailand & Eurozone

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