Monetary conditions tightened marginally in China’s onshore bond markets in September, after the People’s Bank of China (PBoC), China’s central bank, turned less dovish.

This caused slight negative performance month-on-month in the Bloomberg Barclays China Aggregate Index, the main benchmark for the onshore bond market.

The PBoC took its policy stance because economic data continued to show a further recovery, and because it is focused on avoiding risks from excessive easing and stopping monetary stimulus from spilling over into asset-price inflation.

Two reasons why this has a significant impact:

Firstly, FTSE Russell is the third major index provider - after Bloomberg Barclays and JP Morgan - to include China fixed income into its benchmark.

This inclusion acknowledges the progress China has made in opening up its onshore markets to overseas investors and reforming onshore market processes.

Secondly, this latest round of inclusion should prompt further inflows into China’s bond market and yuan appreciation.

We expect a rebound in growth as economic data continues to show a strong recovery supported by the aggressive policy actions taken in the past six months.

In the mid-term, key risks remain the sustainability of the COVID-19 containment, the possibility of a second wave and potential further deterioration in Sino-US trade relations

The policy direction in September shifted from cyclical support to structural initiatives.

In the PBoC’s 3Q meeting they mentioned a continuation of low lending rates via deepening reforms, improved cross-cyclical policy framework and striking a long-term balance between stabilizing growth and preventing risks.

Looking through 4Q, there's still a chance that the market for government and policy bank bonds will rally after the recent market sell-off. Market volatility and risk-off sentiment may rise on escalating US-China tensions.

In terms of fundamentals, Evergrande's short-term liquidity is manageable although it was already tight - sales have been robust so far.

The company continues to spin off some non-property subsidiaries and we believe it has significant asset scale on its balance sheet that may provide liquidity if needed.

In the near term we will need to assess potential negative impact on banking relationships, broader access to financing as well as any sentiment hit to sales growth in coming months. These pose the key additional risks in the near term.

Given its size, Evergrande does pose certain systemic challenges to China and we believe there will be strong willingness to contain any potential spill over impacts to the economy and sector.

The Evergrande news may hurt sector sentiment as markets were already focused on leverage given recently policy announcements.

But while this may create some short-term negative pressure, we see this as a medium term positive and expect the sector to emerge with a healthier balance sheet after companies undertake some of the measures to respond to government pressure.

China’s property sector has seen a wave of consolidation in the last few years and the majority of offshore issuers have now built up reasonable scale and have enhanced funding diversity to respond to any refinancing pressures.

Longer term we remain positive on the sector. The Chinese property sector has seen a wave of consolidation in last few years and majority of the offshore issuers have now build up reasonable scale as well as operational footprint and have enhanced diversity of funding channels to respond to any refinancing pressures.

The top companies in the sector have experience of multiple property market cycles over recent years which would help them respond to any potential refinancing pressure, and this makes us comfortable with investing in this sector, albeit selectively.

On the credit side, the COVID-19 has had a negative financial impact for Chinese credit. It is worth highlighting that we have seen numerous recent policy statements indicating strong support for financial market stability throughout this challenging period.

That suggests limited rollover risk for onshore credit in the coming months and should allay fears of a spike in liquidity pressure and defaults onshore and we do not expect any negative sentiment to spillover to the offshore USD market.

Longer term, we hold a positive outlook on the China high yield sector with the continued accommodative stance of central bank policies, sound credit fundamentals and a supportive technical backdrop.

The yield pick-up relative to global high yield markets continues to be very attractive, providing a firm technical backdrop. In terms of valuations, credit spreads have contracted since March but are still historically wide and we think that investors are getting well compensated given current fundamentals.