This year’s Chinese dollar bond market can be said to have ushered in a big bull market. Investors who invest in the bond market have made great profits, but at this stage, whether they are advancing or retreating is a topic that investors generally care about. Below we Try to make an analysis suggestion for everyone.
I. Review of the Chinese dollar bond market
1. The U.S. phased interest rate cut. On October 30 2019, the US Federal Reserve ended its interest rate meeting and announced an interest rate cut of 0.25% as expected. This is the third consecutive interest rate cut of 0.25% in 2019, bringing the federal benchmark interest rate to the 1.5 to 1.75% range. The interest rate statement deleted the words “take action when needed to maintain economic growth” and replaced it with “the economic data obtained will continue to be monitored while assessing the future interest rate path”, and the market interpreted it as implying that the current round of interest rate cuts has come to a halt. The latest interest rate futures show that the market expects that the chance of another rate cut in December next year is only 67%.
2. Since the beginning of the year, the price of Chinese-dollar US dollar bonds has risen unilaterally, recording a large increase. According to the IBOXX China-US Dollar Bond Index, the price of China-US dollar bonds has recorded a large increase year-to-date (November) (shown below), with a total return of 8.33%. The speed and extent of future US interest rate cuts have not been determined, and the number of bond defaults by mainland issuers has increased, and the market is expected to be more volatile. The possibility of a large-scale unilateral rise in Chinese dollar bonds in the future is low, and there may be a certain degree of price fluctuations. Investors need to pay attention to callback risks.
3. The overall interest rate spread of Chinese-dollar bonds has fallen. The overall spread of Chinese-dollar bonds has fallen by about 30bps, mainly due to the release of liquidity by China’s monetary policy and the provision of corporate financing facilities.
II. Affected Factors of Chinese Dollar Bonds and Forecast of Future Trends
1. The pace of US interest rate cuts is unclear. The Fed cut interest rates by 0.25% after the meeting, and stated after the meeting that the words “take appropriate action to maintain expansion” were deleted, and pointed out that the current level of interest rates was appropriate, which meant that interest rate cuts would be suspended. The Fed stated that it was a bird with a eagle, because the Fed already emphasized that this was a “mid-term adjustment” when it cut interest rates for the first time at the end of July. In response to the escalating trade war between the United States and China, the economic outlook became increasingly uncertain and exacerbated the US economic slowdown. The ISM manufacturing index fell to a 10-year low of 47.8 in September. Therefore, the three consecutive interest rate cuts by the Fed are just preventive rate cuts, not recessionary rate cuts during economic stalls.
As China and the United States reach the first phase of the economic and trade agreement, once the two sides confirm the signing later, the haze that plagues the bilateral and even the world will temporarily dawn. Even if the two parties enter the second round of negotiations, there will be at least a relatively quiet day. After the second interest rate cut, you can watch the progress of the China-US trade talks before making any plans.
In addition, the US’s third quarter GDP grew by 1.9%, of which private consumption grew by 2.9% better than expected, contributing 1.93 percentage points to GDP growth, reflecting that the consumption has not continued to decline, and the risk of a short-term US recession is not high. As the economic slowdown has not been as severe as previously expected, it also leaves no room for the Fed to cut interest rates in the short term.
Although the situation is showing signs of improvement, whether the first round of China-US agreement can be signed or whether it will repeat itself after signing, there are still variables, so the Fed needs to retain flexibility. At present, the federal funds rate is 1.5% to 1.75%, and ammunition is limited. If the interest rate is reduced by 7 more times, a negative interest rate will appear, making the Fed need to retain its strength and pay close attention to developments and US economic data.
2. Since the beginning of this year, the number of bond defaults by mainland issuers has increased. With the continued trade war between China and the United States, economic growth in the Mainland has declined and the number of corporate debt defaults has increased. From January to September 2019, there were 111 new default bonds issued by mainland issuers, involving a default of RMB 73.57 billion, and 26 new default entities for the first time. The default rate of mainland corporate bonds in 2018 was between 0.6% and 0.7%, and the default rate of mainland corporate bonds in 2019 climbed to about 1%, setting a record high.
3. The state has continued macro-control over the real estate market, and developers are under increasing pressure on financing. In the Politburo meeting held in July, the central government continued to stabilize expectations, stressing that “housing is for housing, not for speculation,” breaking market expectations that the government will use real estate to stimulate market dependence during the economic downturn. Under the current overheating land prices, some real estate developers have also become more cautious in buying land. In terms of real estate financing, the NDRC has issued new regulations aimed at strengthening the review of overseas financing activities of real estate companies. The new policy stipulates that foreign debt issued by real estate enterprises can only be used to replace mid- and long-term overseas debt due within one year.
Summary: Year-to-date, the price of Chinese-dollar US dollar bonds has risen unilaterally and recorded a large increase, mainly due to the continued Sino-US trade war, the continuation of global central bank interest rate cuts, Brexit, and international geopolitics. In view of the large increase in bond prices, the future pace of interest rate cuts in the United States is uncertain, and the number of mainland corporate bond defaults has increased, and the market is expected to be more volatile. In addition, the state has continued macro-control of the real estate market and increased financing pressure on real estate developers.
Therefore, the possibility of a large-scale unilateral rise in Chinese dollar bonds in the future is low, and price fluctuations are likely to occur. Investors need to pay attention to the correction of market prices.
III. Investment strategy recommendations
1. In view of the increase in the default of Chinese dollar bonds, investors who have doubts about the bond market should avoid holding single bonds and can invest in Chinese dollar bond funds, because the advantage of bond funds lies in entrusting professional fund managers to select bonds and uniform management. Through the investment portfolio of generally holding more than 100 bonds, the effect of diversifying investment risks can be achieved, which can effectively resist the risk of default and market fluctuation of some bonds.
2. Investors should try to avoid holding single small real estate bonds and long-term real estate bonds.
3. If bond investors who need a more stable investment, they can choose to subscribe to tiered bond funds with higher security. Hierarchical funds that have become popular recently have the biggest feature of dividing and dividing fund returns and risks into two parts: priority and inferior, suitable for investors with different risk and return preferences. Bond investors with lower risk appetite can subscribe to priority shares, enjoy priority distribution rights, and have higher security. If major changes occur in the market, the inferior shares will bear the investment loss first, which will guarantee the principal and income of the priority investors to a certain extent.
Bank of China Private Bank (Macau)
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