China’s entry in Bloomberg Barclays Global Aggregate (BBGA) Index from April marks a milestone in the opening up of its onshore bond market. China’s inclusion in other flagship indices i.e. FTSE Russell World Government Bond Index (WGBI) and the GBI-EM Global Diversified may be announced by Sep/Oct with effective dates of inclusion in 2020, in our view. Rates strategy: risk-reward is turning more balanced after recent selloffs. Expect further rise in foreign demand for policy bank bonds, which make up >50% of China’s weight in BBGA, with CDB a likely proxy for exposure.

Bloomberg Barclays Global Aggregate (BBGA) Index: Beginning 1 April, China officially enters Bloomberg’s flagship Global Aggregate bond index. The inclusion will be phased in over 20 months. At full inclusion, China will take up about 6% weight, with a CGB vs. policy bank bonds mix of 47:53. China exposure still looks attractive with a weighted-average yield of ~3.5% compared with a composite yield of 1.8% in the BBGA universe. Pre index inclusion in 1Q19, the foreign holdings CGB were little changed, but policy bank bonds attracted strong foreign demand with total inflows of CNY53b/+16% in 1Q19 from Dec 2018.

FTSE Russell World Government Bond Index (WGBI): FTSE Russell announced in April that China bonds have been put on watch list for a potential upgrade of its “market accessibility level” from 1 to 2, making it eligible for inclusion in the flagship WGBI. If the index provider decides to add China, it may confirm this in September together with a timeline for inclusion. As WGBI is a government bond index, only CGB will be eligible. We think the effective date of adding China to WGBI could come as early as mid-2020 and the phase-in period could take around 18 months. We estimate total foreign inflows of USD120b.

GBI-EM Global Diversified: The index provider indicated that it will conduct an investor survey over 2Q to 3Q and if they decide to add China, the index weight will be about 7-10%. An announcement may come in 3Q19. We think the effective date for adding China to the index could be in early 2020 with an 8-10 month phase-in period. We estimate total foreign inflows of USD20b.

China rates strategy: The CGB curve has corrected 25-30bps higher since we tactically lowered our outlook to neutral from positive. We think risk reward is turning more balanced and recommend investors to buy on dips. It is unlikely to see a repeat of extended selloffs like 2017 when market liquidity tightened significantly on China’s deleveraging drive. The PBOC’s monetary policy stance is expected to be neither too tight nor too loose. We prefer CDB over CGB, on expectation of further pickup in foreign demand from BBGA index inclusion and still good 40-50bps spread over CGB. Trade idea: Buy 5y CDB 2/2024, Enter: 3.70%, Target: 3.30%, Stop: 4.00%.

Source: Maybank Research - 25 Apr 2020