Rates: Contagion fears reflect in lower DM yields

Dealing with global uncertainties with one eye on FOMC.
Eugene Leow21 Sep 2021
    Photo credit: Unsplash Photo

    Worries about real estate developer China Evergrande Group’s resulted in a risk-off start to the week with global stock markets down sharply. In the rates space, moves were arguably more muted. While the S&P 500 fell by 1.7%, 10Y US Treasury yields fell by 5bps (to 1.31%). This development was also echoed in Europe where stocks appear to be much harder hit than govvies. Some contagion appears is happening as weakness spreads from Evergrande to regions (and assets) beyond China. The VIX rose above 25, touching levels not seen since May. We think that the outsized reaction in global markets may be a function of having too many uncertainties bunched into this period (Evergrande’s woes, Fed taper, US fiscal bills, US debt ceiling). It probably does not help that risk taking (especially in equities) has gone on for an extended period and may be vulnerable to a correction. Clarity on how the authorities intend to manage the restructuring is probably needed to calm jittery markets. That said, developed market yields appear to be holding well within recent ranges. Even as this bout of uncertainty persists, government bonds still must keep one eye on the FOMC meeting outcome this Thursday (2am, SGT). 


    Despite the surge in volatility (regulatory crackdowns and slowing economic growth also added to worries), CNY interest rates have been generally calm. There are two angles to view rates / yields – liquidity stress and anticipated policy response to current conditions. On the former, there has been no obvious stresses in money market rates (caveating that onshore markets are closed for Monday and Tuesday). The 7D repo rate has been generally holding in the 2-2.5% range while the 3M SHIBOR is still hovering around 2.4%. We note that CNY NDIRS rates (which have been trading) have held steady. Taken together, these suggests that the rates space does not seem overly concerned with the declines in equities or credits over the past few weeks (for now). The overall response from rates is muted compared to the period of 2015/16 when there were China hard-landing fears.


    We reiterate that the authorities are likely to only take measured easing steps to offset these challenges. The People’s Bank of China (PBoC) has already cut RRR (and will probably cut another round in the coming weeks) and injected liquidity to ensure that risks of a disorderly spike in short-term rates is minimized. However, to expect a sizable move lower in short-term rates below 2% appears premature. Similarly, 10Y CGB yields appear resistant to head below 2.8%. While slowing economic growth does suggests that further easing is likely, the magnitude of easing may not be that large. In any case, the authorities appear to be focused on other priorities including containing property prices and to perhaps instil discipline into selected sectors of the economy. With these in mind, overly low interest rates will not be appropriate. The upshot is that there are no obvious signs of stress in the rates space. 10Y CGB yields also appear to be in the 2.8-3.0% range as market participants realize that the PBoC is likely to only allow a modest loosening of monetary policy. All eyes will be on how the market reacts when it reopens onshore on Wednesday.

    Eugene Leow

    Senior Rates Strategist - G3 & Asia
    [email protected]

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