China Yield Premium Over U.S. Vanishes With More Outflows Seen

(Bloomberg) — China’s yield advantage over Treasuries disappeared for the first time in more than a decade, paving the way for more capital outflows to follow the recent record exodus from the Asian nation.

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The yield spread between Chinese 10-year bonds and comparable Treasuries turned negative on Monday, the first time it has done so since June 2010. The move has been coming for weeks as the Federal Reserve starts on an aggressive rate-hike cycle while China looks set to ease further.

Already, global funds have have sold almost 90 billion yuan ($14 billion) of Chinese sovereign debt in the past two months as the nation’s yield premium vanished. As investors including Pacific Investment Management Co. and AllianceBernstein Holding LP cut holdings, analysts are starting to question when the yuan would feel the knockon impact and weaken.

“Treasuries have been pricing in a multitude amount of hikes,” said Edmund Goh, head of China fixed income at abrdn Plc “Investors are concerned about yuan valuation if China no longer has a higher interest rate advantage.”

The onshore yuan dropped 0.5% in March against the dollar, and was down 0.1% on Monday to trade at 6.3724.

There is growing expectation that the People’s Bank of China would have to ease further — with a key lending rate in focus this week — as the economy struggles with widening Covid lockdowns. The premium on China’s 10-year bonds has fallen from more than 100 basis points since the start of the year as money markets price the sharpest pace of Fed tightening in almost three decades.

Outflows from China’s debt markets will continue in the short-term, according to Xing Zhaopeng, senior China strategist at Australia and New Zealand Banking Group. He expects the U.S. yield will have a 15 basis point advantage over Chinese peers next year, with 10-year Treasuries at 3%.

Global Funds

Global funds held 10.8% of Chinese sovereign bonds as of last month, compared with 11.1% in February. Goldman Sachs Group Inc. earlier trimmed its bond inflow forecast for China to $100 billion this year, from as much as $140 billion.

China’s 10-year yield rose one basis point to 2.76% as data on Monday showed factory gate prices rose more than expected in March. However, that’s unlikely to deter the PBOC from easing as a lockdown in Shanghai threatens to undermine the nation’s 5.5% growth target this year.

Some analysts are sticking to their bullish bets on Chinese assets given that the inflation rate in China is still below that of the U.S. “China’s real yield is still higher than the U.S., indicating that the yuan will likely remain basically stable for now,” said Qi Gao, a currency strategist at Scotiabank in Singapore.

(Updates throughout)