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50 Basis Points: China CDS update

23 April 2020 by jbchevrel

Earlier this week, the PBoC announced a further cut to the 1-year loan prime rate from 4.05% to 3.85%. Another step in loosening monetary policy. Last week’s publication of Q1 GDP growth numbers (-6.8%) confirmed the amplitude of the damage. CNY-denominated govies (CGBs) have been trading relatively well this year, supported by the PBoC’s reductions notably to the 1-year and 5-year Loan Prime Rates (LPR), the 1-year Medium term lending Facility (MLF), and the 7-day and 14-day reverse repo rates. In addition, the PBoC has also directly injected trillions of CNY into the banking system, through its OMOs and by reducing RRR for banks. Despite these moves, the consensus is that the PBoC still has space to loosen monetary policy further. CGB yields could be supported if that is the case, currently 5-year CNY CGB yield is ~2.0% and 10-year is ~2.6% i.e. 25 higher than UST. Part of that is offset by lower liquidity of CGBs versus USTs and risks related to restrictions around capital flows in China. In FX, CNY has been one of the out performers in EM this year. Thanks to strong FX (vs EM, not vs USD), CGBs are one of the best performing lccy govies in JPM EM LCCY index. The CNY onshore credit market has remained resilient, despite the elevated debt levels of many state-owned enterprises. S&P China Corporate Bond Index shows small but positive returns. Because 1/ Many investors in CNY onshore credit tend to be buy-and-hold people, as opposed to fast money. 2/ Many CNY credits benefit from an implicit state guarantee. Vs USD, CNY has weakened past the 7 handle, probably more due to USD strength. Officially at least, the PBoC has stated that they do not purposely intend to devalue CNY to support exports and thus growth. Officially, they aim to keep the CNY stable over the long term. The spread of USD bonds of Chinese companies widened, but not by much in IG, outperforming other EM IG corp by 100bp+ YTD. China CDS has also outperformed in this move, the 5y is now at 50bp while many other spreads have doubled, tripled, from much higher levels. From a valuation perspective, it seems that there are more compelling buying opportunities for EM investors outside of China today.