Addressing Major Fixed Income Problems In Beijing

Dec. 31, 2013 3:02 AM ET
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Contributor Since 2013

I start to invest in China share market when I was 15 years old. Nowadays, I have been in the market for more than ten years. My strategy is M&A arbitrage and also have tried finding low P/E,small cap stocks. I have studied in United States for Master of Finance degree. During those days, I worked for a local investment firm which major in macro economy. Hope my experience and knowledge can improve the communication among emerging markets and U.S. market.

Addressing Major Fixed Income Problems in Beijing

Q: When will the monetary policy adjustment begin?

A: The monetary policy will continue tight in the first quarter of next year. The interest rate will stay at a high level. However, the turning point may come at the second or the third quarter because of the slowdown of economy growth, the increasing financial system risks or the impact of global economy. PBOC may change its monetary policy because of those. If the inflation rate in the second quarter is pretty high, there will only be a small adjustment, and the price of capital will remain high. If there is a significant slowdown in the third quarter, which is the result of structural adjustment, the monetary policy may have a great change. Risk free rate may drop down. There is little chance that PBOC would significantly change the benchmark rate.

Q: How about next year's foreign capital inflow?

A: First of all, whether there is inflow depends on domestic economy not other countries'. If domestic economy keeps strong, the inflow will not change. Second, from the point of PBOC, to realize the globalization of RMB, PBOC should stabilize and appreciate RMB. RMB is expected to be appreciated next year. Third, the interest rate arbitrage has been there for a while and will keep on. Although the tapering has begun, the arbitrage opportunity is still very attractive. Fourth, PBOC keeps a reserve of 366 billion USD. Even if there is a big turbulence in the forex market, central bank will have the ability to keep RMB stable. In a word , the trend is still foreign capital inflow, but at a low pace.

Q: How about next year's inflation?

A: We think the inflation next year is more like this year, hard to be so high. First, we think that the growth power of next year is still not strong. Money supply is slowing. We should not overestimate the inflation. Second, because of the stable United States economy growth, USD is expected to be strong. Commodity price will be lower. There is little chance of imported inflation. Third, because the large supply of livestock, the price of livestock will not increase much. We think next year's inflation will keep at the same rate as this year, around 2.7%. The second quarter will go to the highest point.

Q: Which rate will become the benchmark rate?

A: As the advance of interest rate marketization, the market is finding an anchor. When pricing other financial assets, participants should just remember to add a certain risk premium above the anchor. From now on, there are three existing candidates.

  • Shibor

The introduction of the interbank deposit further accelerates the formation of China's benchmark rate. Long been marginalized Shibor rates has become the darling of the financial markets. But Shibor rates still have some imperfections. The periods only limit to a year. The trading volume is very small. Although the introduction of NCD will help to form a longer term yield curve, the NCD still needs time to be popular and marketable.

  • LPR(Loan Prime Rate)

National Inter-bank Funding Center starts to public LPR at 25th October. According to the quote of each bank, excluding the highest and the lowest one, NIFC calculates the value in a weight averaged manner and gets the average loan benchmark interest rate on 11:30 A.M. Until now, NIFC only provide one-year interest rate.

  • Treasury Yield Curve

At the Third Plenum which is first proposed is that "the Treasury yield curve reflects a sound relationship between market supply and demand". The government has the intention to make treasury yield curve as the financial market benchmark. However, the situation that major participants of treasury market are those commercial banks and the structural change of banks' balance sheet makes treasury less representative. That is why treasury yield curve is not a shift lady for the market. Nowadays, the treasury yield curve has several shortcomings. The first is the insufficient of short term products and discrete publication of major products. The second is that banks and market have two different supervision systems. The chance for arbitrage is low, which cause one product has different prices. The third is that the volume of treasury is not sufficient. Investors are not educated for the treasury market.

PBOC has tried hard to put forward the interest rate marketization. However, the above three all have its own drawbacks. It is hard to guess which one will finally be the benchmark.

Q: As a traditional settling period, will the first quarter be the golden period?

A: For the first quarter of next year, we are cautiously optimistic that the bond investment opportunities are weaker compared to previous years. According to estimated commercial bank funding costs {= (current year periodic interest rate +1) / 2 * deposits accounted + (1M Shibor +3 M Shibor) / 2 * +3 month interbank liabilities accounting for financial products Yield * guaranteed wealth management products scale the current proportion of about 2.63%}, compared to December 2012 increased by 80 BP, which lifted the deposit costs 52 BP. If we consider off-balance sheet financial factors, the cost of capital rises more sharply. Under such a high cost of capital, banks have no incentive to take on more debt. On the other hand , as the settling of the main insurance premiums traditional quarter is the fastest growing fund , commonly known as a good start , but with all kinds of high-yield finance , underinsured attractive , so the first quarter of next year might be a good start insurers is very low , even with new money , according to this year's 85% investment ideas will be configured in other investment ( trust , loan schemes , etc.) , and therefore also affect the size of a quarter with debt . Big banks current configuration does not demand as in previous years. Therefore, our expectation for the first quarter of next year bond market is cautiously optimistic.

Q: Is there any upside space for the yield curve?

A: We believe the next 1-2 quarters, the interest rate yields will remain now that stalemate, that there is no room for upside, there is no dropping conditions. First, since June this year, resulting in rising yields is mainly due to: the interest rate market to accelerate, neutral tight monetary policy, bank debt maturity mismatches lead to reduced investment scale, platform and financing platform for an unlimited amount of financing, which four dominant factor has been fully reflected in the second half of the yield curve, is expected no recent precipitating factors leading to greater yields rose to 5% and can be maintained at such a high level. Second, with the whole social financing costs up, bond yields will be the central uplift, and therefore yields dropping to below 4% is also unlikely. Therefore, we believe that in the case of more than a few factors have not changed, the yield would be stalled for some time.

Q: Is there any chance that NCD will replace CD?

A: Interbank deposit on the duration and nature of the liability similar to banks, both in itself there are some substitution effect. Interbank deposit are standardized products that can be mobile, and can pledge to reduce friction and funding liquidity premium, interbank deposit interest rates will be lower than its peers store, which will be expected to form a significant diversion to banks. But to banks in meeting the individual needs of organizations have the advantage. Most of the business to banks from the branch level and small stock lines, lines to banks under the supervision of the central bank is also a powerful weapon to bypass. The interbank deposit certificate issued by the head office, and is currently available only in the 10 pilot institutions, the market is starting among the NCD over a longer period of time and the line will remain the same below to banks coexist.

Q: How about credit risk next year?

A: We believe that credit risk next year mainly refinancing risk. With limited funding and a broad spectrum of interbank interest rates to rise next year, the financing environment worsened, the larger the amount of the bond maturity. Meanwhile, next year is still facing a "capacity to" issue; we recommend that the steel, nonferrous metals, coal and other industrial sectors of the private debt should be circumvented. There are some technical debt default risks. However, the financial institutions associated with it will be supported to avoid breach of the industry, "the first single," because such events both for the enterprise itself or related financial institutions are big negative impact. Therefore, the credit risk arise at some point will be resolved. However, if the cumulative risk more, do not rule into a solvency risk. From an economic point of view the situation next year, or two quarters of next year the economy was flat with the fourth quarter of this year, the third and fourth quarter of next year there are downside risks to the economy, but there is a bottom line growth, and therefore will not be much downside. So in this context, a major outbreak of the credit risk is unlikely, but does not rule out individual credit risk.

Q: How about the supply of municipal bond?

A: The first half of next year the municipal bonds relatively large supply. Since August this year, the NDRC approval for the city to vote bonds loose, led directly to the second half of the municipal bond supply is large, but according to our survey, although part of the issuer has to get approval, but because of funding constraints, lack of demand and revenue considerations higher rates of other reasons have chosen to defer part of the issue or issue. According to the policy provisions, approvals valid for one year or less, but if the issue is not before the end of April will face up 2013 Annual Report and other issues. Therefore, expect to get approval of the existing city to vote bonds will be issued early in the first quarter or second quarter of next year. We are also concerned that, due to the "pledge of accounts receivable" and so many problems, NDRC approval is expected next year than this year tighter. In addition, next year will be the NDRC debt sustainability focus.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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