Ok, so remember how, first thing Monday morning, we noted that 10Y yields in China hit 22-month highs overnight?
Right. Remember what we said was the proximate cause? Here’s a refresher:
(Very) long story, (very) short, you’ve got lackluster PMIs bumping up against i) an effort to rein in speculation via tighter monetary policy (although the PBoC is going the “stealth” route with OMO hikes), and ii) efforts get a handle on the (still) out of control shadow banking complex (think: WMP WMDs).
Well needless to say, this is affecting the corporate bond market as well. “As of the end of April, a dozen companies from steelmakers to construction firms this year have defaulted on their corporate bonds, unable to refinance their debts at the higher rates that are partly a result of the regulatory push,” WSJ wrote late last week, adding that the default figure “matches the record hit during the same period last year, when the economy was under greater pressure from accelerating capital outflows.”
That’s causing more than a few folks to get concerned.
Case in point: Deutsche Bank is out on Monday morning with a “Part II” of a note they penned around this time last year. As the bank writes, “we certainly didn’t foresee writing a second note with the same title, more than a year after our last note on Apr 20, 2016.”
Basically, Deutsche Bank “doesn’t always write sequels to bond market notes, but when they do, they prefer China.” More below…
Via Deutsche Bank
We certainly didn’t foresee writing a second note with the same title, more than a year after our last note on Apr 20, 2016.
At that time, the sharp selloff in onshore bonds was short lived – AAA corporate yield widened around 60bp in about a month – and it was driven mainly by pick up in onshore bond defaults, especially SOEs. This time, it’s sharper and longer – AAA yield & spreads are almost 200bp and 100bp wider respectively in the past 6 months or so (Figure 1) – because of China’s focus away from growth to deleveraging. This is far from over in our view.Every day we see headlines on new regulations trying to control leverage in different parts of the system – WMPs, insurance companies, banks, etc. Having said this, we do believe in China’s ability to make a U-turn quickly if the situation goes beyond control, and see these changes as a long term positive, hence we are not overly worried as of now.
Local bond markets are practically shut for corporates. In fact, YTD issuance is down 40%+ yoy and net issuance has been negative in three out of the first four months this year. A number of issuers are being forced to cancel bond issuances (over RMB100 billion YTD) and there were reports (Bloomberg) of even CDB halting issuance (though subsequently denied). Some AA corporates are now issuing at north of 7%. All this clearly means that supply in the USD bond space will remain strong in the medium term, particularly from nonproperty HY corporates. IG corporates likely still have access to the bank loans, while property companies continue to be constrained by sector controls. We do think though that in the very near term, USD issuance might slow a bit from the strong pace earlier this year, mainly for two reasons: One, China’s push / approvals might slow down a bit with the stabilization in FX reserves, and two, investor demand might be marginally impacted with all the negative headlines surrounding onshore markets.