Chinese equity sell-off leaves locals “more cautious” on debt

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Buy-side traders in the Chinese debt markets are noting some effect from the equity sell-off, which was triggered by concern around government and regulatory intervention in sectors including education and technology.

“Seems spreads in debt widened significantly with activity muted for us,” noted one trader.

“Tech names were softer 10 -15bps in the long end,” said another.

The potential for the regulation to impact industry is certainly not new, yet the changing outlook for firms in the Chinese tech and education sectors may have caught some investors unaware.

One trader said, “If we look at Alibaba the signs were there and the smart money reduced exposure. Problem is everyone is chasing the returns and it has been easy money for 18 months. Brakes being applied by PRC is a normal part of the market in China, you have just got to read the signs and be prepared to forgo the short term gains. Unfortunately, most investors have become accustomed to playing momentum and forget the PRC can swing it in the opposite direction with a policy shift.”

An assessment by equity analysts at Morgan Stanley found a downside of over 20% could be possible in the stock market “if weakened sentiment and accelerated selling persist.”

In a note dated 26 July the analysts wrote, “Based on our recent investor conversations, we sense that a broad-based reassessment of Chinese equity risk is now under way. This has built up over the last few months based on regulatory actions by the authorities – but last weekend’s developments in the education sector have led a further acceleration of investor reappraisal and repositioning.”

Buy-side bond traders have observed some differences in the response locally to this clampdown, which marks it out for the level of uncertainty generated.

“The interesting change in sentiment has been more with locals,” says one senior trader. “This is the most cautious they have been for a while. Much like the property and education sector people are trying to assess the regulatory changes coming through.”

However, on a positive note, the changes will improve credit quality noted one trader on background, so while the period of transition caused by new rules coming in is likely to drive volatility, there is not expected to be a liquidity problem.

©Markets Media Europe, 2021
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