- China did not offer a growth target for 2020, but announced massive fiscal stimulus to support the economy;
- For monetary policy, the policy stance appears to be neutral. We expect targeted measures to support the economy, focused on specific areas, like small-and medium-enterprises;
- Given the improvement in financing conditions, we expect demand for credit bonds, particularly high-yield bonds, to improve, and expect them to outperform investment grade credit in 2H20.
'Two Sessions' - no GDP growth target, policy focused on maintaining stability & pushing reforms
The postponed 'Two Sessions' caught the world's attention since it was the first major policy event in China since the successful control of the COVID-19 outbreak and also because it marked the final year of the '13th Five Year Plan.'
Importantly, the government work report presented at 'Two Sessions' didn't set a specific target for GDP growth. This marks a break from the past where GDP targets were at the top of the report and attracted a lot of attention and debate.
Of course, not setting a full-year GDP growth target does not mean abandoning economic growth. In fact, the economic growth target has been reflected in fiscal and monetary policy indicators.
Fiscal policy to support the economy
For example, in the government work report presented at 'Two Sessions,' the fiscal deficit rate for 2020 was set at more than 3.6%, corresponding to a RMB 1 trillion increase in the fiscal deficit compared with 2019.
Additionally, the government approved RMB 1 trillion in anti-epidemic government bonds and increased special bond issuance from local governments by RMB 1.6 trillion.
Quality of growth in focus, future reforms likely
Overall, the emphasis of this government work report is on maintaining employment and providing stable fiscal and credit support for the economy.
Removing economic growth targets affirms that the Chinese government's goal is the quality of growth rather than the quantity. Further, we believe this signals that future policies will be focused on promoting economic reform.
As for monetary policy, the policy stance appears to be neutral. We expect the central bank will maintain stable market liquidity, but with targeted measures to support the economy.
This is a crucial distinction to make, however. The core of the central bank's policy is to avoid 'flooding' markets with credit, but instead to make gradual changes to monetary policy to support the economy.
With this in mind, further interest rate cuts are likely, but cuts will likely be small, and targeted at specific areas of the economy.
What is 'Two Sessions'
'Two Sessions' refers to the annual meetings of China's National People's Congress (NPC) and the National Committee of the Chinese People's Political Consultative Conference (CPPCC) in Beijing.
These meetings are usually held annually in March and they set the policy direction for the coming year. This year's meeting was postponed from March to May because of disruption caused by the COVID-19 outbreak.
Other aspects are basically in line with expectations. Real estate policy stayed more or less the same. The government maintained its policy guidelines of 'houses are for living in, not for speculation' but included policies promoting urbanization, community renovation, and land reform – all of which should support real estate demand and investment.
As for monetary policy, the report mentioned that the central bank will further reduce rates and increase the size of total social financing, the aggregate measure for credit in the economy.
China fixed income: latest market updates
After a wave of gains from February to April, China's bond market saw a correction in May.
Bond yields rose across the board, with the largest rises for five and 30-year government bonds of as much as 20bps.
Ten-year yields are up by more than 18bps since the end of April, but have stabilized at around 2.7%, which we see as a key support level.
In terms of credit bonds, new issuance remains high. Short-term credit spreads have narrowed, while longer-term spreads have expanded slightly.
In the high-yield space, low-grade credit bond classes performed better than high-grade, reflecting an increase in market risk appetite.
Why did China's fixed income markets see a correction?
There was a marked improvement in economic and credit data for April.
Industrial output turned positive, inventory destocking picked up, and infrastructure, real estate and manufacturing demand rebounded.
Export data exceeded expectations, corporate loans and bond financing continued to grow rapidly, and more accommodative credit policy showed in the numbers.
That said, China's central bank is now under pressure.
Hawkish voices in China are debating the 'monetization of fiscal deficits,' arguing that the central bank should not finance the fiscal deficit and that fiscal expenditure should not be excessive.
The market is now beginning to worry about the central bank's overall monetary policy stance, particularly now that market supply pressure has increased after local governments greatly increased their bond issuance.
2H20 Outlook: Cautious on uncertainty from external factors; focused on industry leaders
As we move into 2H20, we remain cautious about the risk outlook.
A number of factors are prominent, including ongoing US-China trade tensions, geopolitical issues around the world, oil price instability, and the upcoming US election.
Additionally, there remains the prospect of a second COVID-19 outbreak. As such, fixed income will remain an important outlet for investors amid uncertainty.
Additionally, given the improvement in financing conditions and the decline in default rates, we expect demand for credit bonds, particularly high-yield bonds, to improve, and we expect them to outperform investment grade credit in 2H20.
At present, we see some potential for a correction in the investment grade credit bond space, which may present opportunities in the coming months.
Sector-wise, we are optimistic on prospects for real estate, infrastructure, consumption, and medical industries, and we are particularly focused on leading companies in those spaces.
We are avoiding companies exposed to foreign trade, as well as zombie state-owned enterprises and air travel companies.
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