China: Ministry of Finance auction casts shadow over dim sum

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The Chinese Ministry of Finance successfully completed its second offshore renminbi bond auction, but poor investor demand for the offering raises questions about the future of the CNH bond market.

By Noah Sin

The results of the Ministry of Finance’s offshore renminbi bond auction at the end of November, raising Rmb7 billion ($1.06 billion) from three tranches, revealed some interesting trends. 

Institutional investors focused on the shortest tranche – a Rmb4 billion ($600 million) two-year bond – putting in Rmb10.7 billion of bids for the paper, which was priced at 3.90%, according to data published by the Hong Kong Monetary Authority (HKMA) on November 30.

The Rmb2 billion five-year tranche attracted Rmb3.7 billion of bids and was priced at 4.10%, while Rmb1 billion of bids came in for the Rmb500 million 10-year tranche, which was sold at 4.15%.

Nathan-Chow-160x186
Nathan Chow, DBS
Foreign central banks and monetary authorities took another Rmb300 million of the two-year note and Rmb200 million of the five-year paper, according to the Ministry of Finance.

The bonds, which were sold through HKMA’s Central Moneymarkets Unit, settled on December 4.

The pricing of the CNH bonds reflects the difference in liquidity conditions between the onshore and offshore renminbi markets, Ken Cheung, senior Asian FX strategist at Mizuho, tells GlobalRMB, Asiamoney’s sister publication.

“Since June, onshore CGB (Chinese government bond) yields have moved quite rapidly, whereas offshore yields have not moved as much,” he says. “Liquidity is obviously tightened in the onshore market. But this auction suggests that the impact of that tightening hasn’t spilt over to the offshore market yet.”

Three-, five- and 10-year onshore Chinese government bond yields had risen rapidly in the weeks before and were trading at 3.77%, 3.87% and 3.91% at the end of November respectively, according to China Central Depository and Clearing’s data. 

The MoF paid a 50 basis point premium for the three- and five-year notes in June, when the five- and 10-year CGB yields stood at 3.5418% and 3.5415%, respectively. 

GlobalRMB’s tracker shows this is the fourth consecutive auction where investor demand has fallen for the five-year tranche. 

Aggregate bid volume fell from Rmb11.9 billion in June 2016 to Rmb3.7 billion at the November 2017 auction, while the size of the tranche more than halved, from Rmb4.5 billion to Rmb2 billion. 

On the other hand, Cheung points out that Bond Connect, which launched on July 3, has given offshore investors access to onshore fixed income securities from Hong Kong for the first time, further reducing the need to buy into the dim sum market.

“Now that we have Bond Connect, offshore investors can go for onshore CGBs, which have much better liquidity than offshore government bonds,” he says. “That inevitably takes some of the demand away from this auction.”

Foreign investors have been stocking up on Chinese bonds, with aggregate ownership of domestic renminbi bonds surging to Rmb1.1 trillion as of September, from Rmb852 billion at the end of 2016, according to CEIC data. Treasury bonds made up 48% of such holdings.

However, a sell-off in the onshore market and the resulting spike in yields have caused foreign market participants using the Bond Connect to focus on high-yielding short-term negotiable certificates of deposit (NCDs). Three-month NCDs were yielding as much as 5.2% as of December 5, Nomura says in a note. 

RMB worries

Nathan Chow, economist at DBS, says expectations of renminbi depreciation in 2018 may have also soured appetite for the MoF’s bi-annual CNH bond auction.

“I think people are now unsure whether renminbi appreciation will continue in 2018,” he tells GlobalRMB.

He forecasts renminbi depreciation of 2% to 3% in the coming year, as onshore credit supply tightens and the property sector slows down. 

The anticipated hikes in interest rates by the US Federal Reserve will create more downward pressure on the Chinese currency, he adds.

The renminbi defied widely held expectations of depreciation in 2017; as of the end of November, it had appreciated 4.95%. But the combined effect of the rate hike and tax cuts being introduced by the US government could have an impact on the renminbi, as they could accelerate capital outflows from China, targeting US assets.

The MoF said in an October 24 Q&A that the auction’s downsizing was a response to the decline in the dim sum market. But while the CNH auction shrank, China decided to sell its first sovereign dollar bond since 2004 in October — a $2 billion dual-tranche transaction — putting the ministry’s overall offshore fundraising target in 2017 on par with that of the previous year.

Chow reckons China will stick to this CNH-dollar combination in the future.

“If the renminbi depreciates 2% to 3% [in 2018], as I expect, there will be a need for dollar bond issuance,” he notes. “I am not saying they will issue frequently, but the one in October won’t be the last.”