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Are China's Bonds Nearly as Safe as Treasuries?

Sunday, 10 October 2010 05:22 PM

At a time when governments around the world are facing growing debt, China’s bonds are becoming almost as safe as U.S. Treasuries in the market for insuring against defaults.

Five-year credit-default swaps contracts on the nation’s bonds fell 29 percent in the past month, the biggest drop among the Group of 20 nations, and ended last week at 56 basis points, according to data compiled by CMA and Bloomberg. Default swaps for the U.S. were little changed at 46.

China’s bonds have become cheaper to insure than those of the U.K. and France since August as the fastest-growing economy surpassed Japan to become the world’s second-largest. Moody’s Investors Service said last week it may raise China’s debt rating from A1, five levels below the top Aaa grade.

“Right now the strongest balance sheet in the world is China’s,” Daniel Arbess, who runs the $2.1 billion Xerion fund for Perella Weinberg Partners in New York, said in an interview with Bloomberg Television on Oct. 7. “China can use that balance sheet strength and the political centralized control that it has over its economic policy to literally finance and drive the ongoing urbanization and industrialization of its economy.”

The 10 basis-point difference between contracts on China and the U.S. is the narrowest since at least January 2008, according to data from New York-based CMA, which provides data on the market that suggests both countries should have the second-highest debt rankings. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually in a contract protecting $10 million of debt.

The change in debt insurance costs “shows a global rebalancing,” Brayan Lai, a Hong Kong-based credit analyst at Credit Agricole CIB, said in a phone interview. “I wouldn’t rule out its debt being deemed safer than Treasuries.”

China’s economy will probably expand 10.5 percent this year, the International Monetary Fund said last week, reiterating its July forecast. U.S. gross domestic product will increase 2.6 percent, down from a 3.3 percent growth estimate three months ago, the Washington-based fund said.

The government of Chinese President Hu Jintao controls the world’s biggest holdings of foreign-exchange reserves, with about $2.5 trillion, including at least $846 billion of U.S. Treasuries, according to data compiled by Bloomberg. Government debt will amount to 22 percent of GDP this year, compared with 94 percent in the U.S., 85 percent for France and 82 percent in the U.K., according to IMF forecasts.

Five-year credit-default swaps protecting U.K. government debt cost 60 basis points on Oct. 8, up 13 during the past year. Contracts tied to France trade for 76 basis points, up from 22 a year ago, according to CMA.

While credit-default swaps place China next to the U.S., its bonds are still discounted next to Treasuries.

China’s $1 billion of 4.75 percent bonds due October 2013 rallied in the past month, sending the yield down 17 basis points to 1.54 percent, according to prices compiled by Bloomberg. The extra yield investors require relative to Treasuries widened 14 basis points to 88, according to JPMorgan’s EMBI Global Index, reflecting a plunge in U.S. yields.

China’s debt has returned 8.3 percent this year, compared with 15 percent in Brazil and 12 percent in Russia, JPMorgan indexes show.

A ratings increase may make it cheaper for Chinese companies to borrow overseas. Dollar bonds issued by the finance unit of Cnooc Ltd., China’s biggest offshore oil producer, rallied last week after Moody’s put the Beijing-based company’s credit ratings on review for a possible upgrade.

Yields on the 6.375 percent bonds due March 2012 declined five basis points last week to a record low of 1.47 percent, according to data compiled by Bloomberg.

“The trend is your friend,” Tim Condon, the Singapore- based chief Asia economist at ING Groep NV, said in a phone interview. “China’s CDS will grind lower and lower and lower.”

The yuan advanced 0.3 percent to 6.6706 against the U.S. currency on Oct. 8, from 6.6912 before a five-day public holiday on Sept. 30, according to the China Foreign Exchange Trade System. It gained 2.4 percent in the past four months and touched 6.6700, the strongest level in almost 17 years, before finance ministers used the annual meeting of the International Monetary Fund in Washington to call for faster appreciation.

Twelve-month non-deliverable forwards strengthened 0.2 percent last week to 6.4913 per dollar, reflecting bets the currency will climb 2.8 percent. Forwards are agreements to buy or sell assets at a set price and date. Non-deliverable contracts are settled in dollars. The Dollar Index, used by IntercontinentalExchange Inc. to track the greenback against the currencies of six major trading partners, fell 1 percent last week to a an eight-month low.

The IMF’s steering committee said over the weekend it would “deepen its work” on capital flows, exchange-rate movements and the accumulation of reserves, focusing on the U.S., China, the U.K., Japan and the euro area.

China’s central bank Governor Zhou Xiaochuan said in Washington that policy makers would avoid “shock-therapy” and move the currency gradually, citing inflation and “asset bubbles” as threats to the economy.

Foreign-exchange reserve figures for the third quarter will probably be released this week, which will indicate “the size of hot capital flows into the economy,” London-based Capital Economics Ltd. wrote in a report dated today. A separate government report will probably show property prices climbed 8.9 percent in September from a year earlier, according to a Bloomberg survey of economists.

The nation’s improving credit comes as Chinese policy makers promote greater use of the yuan abroad to reduce reliance on the dollar. The government since the start of 2009 has approved the currency’s use to settle cross-border transactions, opened its interbank bond market to overseas financial institutions and sold yuan-denominated debt in Hong Kong.

“Chinese policy makers want to be seen as a stabilizing factor,” said Jerome Booth, who helps oversee about $35 billion as head of research at Ashmore Investment Management Ltd. in London. “They want to become a reserve currency, and they will become a reserve currency.”

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At a time when governments around the world are facing growing debt,China s bonds are becoming almost as safe as U.S. Treasuries in themarket for insuring against defaults. Five-year credit-default swaps contracts on the nation s bonds fell 29percent in the past month, the...
Sunday, 10 October 2010 05:22 PM
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