Chinese corporates now constitute more than 50 per cent of the USD bonds market in Asia (excluding Japan) as proxy by the JP Morgan Asia Credit Index (JACI) by number of corporate bond issuance, and almost 78 per cent of primary issuance in FY2017.
Into the Year of the Dog, the expectation is that US Federal Reserve will continue to hike rates impacting financial markets around the world including offshore bonds.
Since the start of the year, the 10-year US Treasury rate has increased rapidly by about 49bp from 2.42 per cent to 2.93 per cent at the time of writing. We expect the 10-year US Treasury rate to push through 3 per cent by year-end.
While increasing yield causes bond prices to drop, ample liquidity remains and this may cause investors to shy away from the offshore bond market.
Bond supply should continue to be robust as China onshore funding cost continues to increase, making the offshore bond market a more attractive financing channel for Chinese corporates Given rising treasury yields, we prefer short-dated high-yield bonds.
The offshore bond market prefers the three-year or below tenor as it provides investors with a good balance between a lower interest rate risk and sufficient credit spreads to earn a minimum yield and buffer the rising treasury yields.
Indeed, the bond issuers have been meeting investors’ demand for lower duration bonds since the beginning of 2018, a trend that is expected to continue.
According to JP Morgan Asia Credit Index, the average duration of non-investment grade offshore bonds averages about 3.6 years.
Liquidity remains ample despite subdued fund flows since the beginning of the year.
Recent low net inflows from EM-Asia saw widening in credit spreads in both Chinese IG and non-IG corporate bonds. Credit spreads measured by JACI non-IG offshore bonds average at 427bp at the time of writing. It gave up most of the spread tightening since the beginning of 2018.
Nevertheless, there is still ample liquidity in the market. In Hong Kong alone, deposits in the banking system totaled USD1.5 trillion at end-Sept 2017. Some of these idle funds could be waiting for a better entry point.
On the credit fundamental front, in an environment of relatively stable macroeconomic, there is no reason to expect a sudden increase in default rate in the Chinese corporate sector.
We expect Chinese economic growth to be stable at 6.3 per cent in 2018, slightly lower than the 6.9 per cent in 2017.
Despite episodes of missed loan repayment from onshore China over the past year, there have not been many high profile defaults by Chinese corporates to date.
Gradual increase in defaults from a low base by Chinese companies would not cause significant concern and would only be seen as a healthy development of the Chinese bond market.
In addition, while the National Development and Reform Commission is controlling the issuance of offshore bonds by corporates, it appears to be supportive of USD refinancing needs by Chinese issuers.
This implies that maintaining market confidence in USD bond issuing Chinese corporates is important on the government’s agenda. It reduces investors’ concern on investing in high-yield non-investment grade bonds.
With a stable economic environment, improved earnings outlook and balanced liquidity supply, Chinese corporates are mostly able to afford higher funding costs with some impact on its profitability.
With the rising onshore funding costs in RMB, the relative advantage of raising debt funding onshore is reducing. Ten-year China Government Bond yield has increased to almost 4 per cent from about 3 per cent a year ago.
We have reasons to believe supply of offshore bonds from Chinese corporate will be ample. Short-dated high-yield bonds will likely be the outperformers of the offshore bond market in the Year of the Dog.Disclaimer applicable to recommendation
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