china: The difference between yields on benchmark debt due in 20

http://www.bloomberg.com/news/2010-10-28/bond-prices-show-pboc-inflation-battle-just-getting-started-china-credit.html http://www.bloomberg.com/apps/quote?ticker=GCNY10YR:IND Related News:Asia · China .Bonds Suggest PBOC’s Inflation Battle to Heat Up: China Credit By Bloomberg News - Oct 28, 2010 10:45 AM PT Tweet (2)LinkedIn Share Business ExchangeBuzz up!DiggPrint Email .China’s first interest-rate increase since 2007 has done little to damp the outlook for inflation and growth in the world’s second-biggest economy, judging from the widening premium investors demand to hold 10-year bonds. The difference between yields on benchmark debt due in 2012 and notes maturing in 2020 grew 7 basis points in October to 129 after reaching a five-month high of 131 this week, according to data compiled by Bloomberg. The gap is smaller in Brazil, where the central bank slowed inflation by raising interest rates three times this year, and India, where policy makers increased borrowing costs five times. Consumer prices in China are climbing at the fastest pace in two years, as prospects for yuan appreciation and 10 percent economic growth attract capital from abroad. Near-zero interest rates in the U.S. and Japan are boosting the allure of higher- yielding assets, spurring inflation and heightening the risk of asset bubbles in developing nations, according to China International Capital Corp. “Long-term debt yields are most sensitive to inflation expectations, which are pretty strong now,” said Tan Weisi, who manages about 400 million yuan ($60 million) as head of Fortune SGAM Fund Management Co.’s fixed-income department in Shanghai. “We prefer debt due in three years or less at this stage to limit risks.” Inflation, Growth Inflation rates of 4.7 percent in Brazil, 7 percent in Russia, 9.9 percent in India and 3.6 percent in China compare with 1.1 percent in the U.S. and 0.9 percent deflation in Japan, government data show. Economic growth in Brazil, India and China is about triple the U.S. pace of 3 percent. The gap between yields on benchmark two- and 10-year bonds in Brazil is 22 basis points, in India it’s 88 and in the U.S. it’s 239. China’s current spread is 19 basis points higher than the 110 average of the past five years. A basis point is 0.01 percentage point. “The yield curve is steepening and has room to become steeper as expectations for inflation have risen,” said Xu Xiaoqing, head of fixed-income research at CICC, the nation’s first Sino-foreign joint investment bank. “China’s economic growth pace won’t slide further next year, and small increases in lending rates won’t have a big impact on expansion.” Higher Rates He forecast the People’s Bank of China will raise its benchmark one-year lending rate by as much as half a percentage point in the first half of 2011 and the gap between yields on two- and 10-year debt will widen as much as 20 basis points, or 0.20 percentage point, as inflation stays above the official 3 percent target. Consumer prices will climb a minimum 4 percent this month, Xu said. Inflation averaged 3.5 percent in the third quarter, the fastest pace in two years, and economists surveyed by Bloomberg are predicting a 3.4 percent rate for the final three months of 2010. The yield on China’s 3.28 percent bond due in August 2020 dropped 9 basis points yesterday and has risen 28 basis points this month to 3.6 percent, according to the National Interbank Funding Center. The central bank raised the one-year lending rate by a quarter of a percentage point on Oct. 19 to 5.56 percent and at least two more increases are expected by the end of next year, according to 12 of 17 economists surveyed two days later by Bloomberg. Reserve-requirement ratios for China’s four largest banks were also boosted this month. Inflows Inflows of capital caused the yuan to strengthen 1.7 percent in September, the biggest monthly gain since a peg ended in July 2005. The currency is up 0.1 percent this month to 6.6874 per dollar in Shanghai. Non-deliverable forwards show traders expect 3.2 percent appreciation to 6.4785 during the next 12 months. The yuan fell to its weakest level this month yesterday, declining 0.1 percent, after the central bank set a lower reference rate for a third day, spurring speculation the government is limiting appreciation. The currency will end this year at 6.63 before strengthening 4.6 percent to 6.34 in 2011, based on the median estimates in Bloomberg surveys of analysts. China’s foreign- exchange reserves jumped by $100 billion in September to a record $2.65 trillion, the biggest increase since Bloomberg began tracking the data in 1995. Five-year credit-default swap contracts on the nation’s dollar bonds fell 8 basis points this month to 60, CMA prices in New York show. Brazil’s swaps are priced at 100 basis points, Russia’s at 143 and those for the U.S. at 38. Default Swaps Credit-default swaps typically decline as investor confidence improves and rise as it deteriorates. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to debt agreements. Government debt investors usually buy the contracts to hedge against a rise in yields. One-year interest-rate swaps, the fixed cost needed to receive the floating seven-day repurchase rate, rose 17 basis points this month to 2.36 percent. Five-year interest-rate swaps climbed 51 basis points to 3.46 percent, according to data compiled by Bloomberg. Credit growth may exceed the government’s 7.5 trillion yuan target this year, Li Ruoyu, a researcher with the State Information Center, wrote in an article published in yesterday’s Shanghai Securities News newspaper. Banks extended 6.3 trillion yuan of new loans in the nine months through September, and it will be difficult to enforce a cap of 1.2 trillion yuan in the fourth quarter as the economy stabilizes and demand for credit remains strong, Li wrote. Industrial & Commercial Bank of China Ltd., the world’s largest lender by market value, said yesterday third-quarter earnings climbed 27 percent to 42.6 billion yuan. Bank of Communications Ltd., the nation’s fifth-biggest bank, posted a 24 percent gain in earnings for the period. --Belinda Cao. Editors: James Regan, Sandy Hendry To contact the Bloomberg news staff on this story: Belinda Cao in Beijing at [e-mail]

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