S&P’s First China Downgrade Since 1999 Could Be Good News For Bulls

Chinese officials have even more motivation to keep financial markets stable after the credit assessor cut the nation’s rating less than a month before the start of a twice-a-decade Communist Party congress. China’s Ministry of Finance said in a statement on Friday that S&P’s cut was “a wrong decision” that ignores China’s sound economic fundamentals and development potential.

After an equivalent downgrade by Moody’s Investors Service in May, the power of the state’s hand was seen. While the yuan soared to a seven-month high in offshore trading within a week amid suspected intervention, knee-jerk losses in Chinese stocks evaporated in a single trading session.

And since S&P’s announcement on Thursday, Chinese markets have displayed a similar resilience. While a state-run lender completed the nation’s biggest sale of dollar-denominated debt since 2014 and yield spreads on Chinese corporate bonds have narrowed, the offshore yuan has gained about 0.2 percent.

“The impact on Chinese asset prices will probably be on the upside,” said Ziyun Wang, a founding partner at hedge fund DeepBlue Global Investment Ltd. “Large state-backed funds will probably buy rather than sell Chinese bonds and stocks.”

Citing the risks from a soaring debt burden, in its first reduction since 1999, S&P lowered China’s sovereign credit grade by one step to A+ on Thursday. The Shanghai Composite Index clawed back a 1.3 percent drop to close higher, and rose 1.4 percent the next day, after the Moody’s cut on May 24 — which China described as “absolutely groundless”. And as short sellers in Hong Kong were squeezed by surging interbank rates, the yuan posted its steepest weekly gain since July 2016.

“The news could read positively in China,” said Qin Han, chief bond analyst at Guotai Junan Securities Co. in Shanghai. “Domestic investors may expect the government to release supportive policies to ease any disruption.”

While the large-cap CSI 300 Index finished unchanged, the Shanghai Composite slipped 0.2 percent on Friday, recovering from a 0.7 percent drop. Hong Kong’s Hang Seng Index lost 0.8 percent. Citing the its “strong institutional and political linkages” with China., S&P stripped the city of its AAA rating on Friday.

And therefore, it is more important now that Chinese leaders support the market. In the lead-up to what will be the most important political event in years, authorities have stressed the need for stability. Shaping President Xi Jinping’s influence into the next decade and replacement of about half of China’s top leadership is expected at the twice-a-decade party congress, which starts on Oct. 18.

Media reports say that before and during the event, orders of ensuring stable markets and mitigating of risks by local brokerage firms have been given by the China Securities Regulatory Commission. According to the sources, leaving the country or taking holidays have also been banned for brokerage bosses by the CSR from Oct. 11 until the congress ends.

According to Becky Liu, head of China macro strategy at Standard Chartered Plc, while the Moody’s cut initially jolted markets, S&P’s move is less surprising. It also comes after a period of strength in Chinese asset prices.

“Chinese fund managers are likely to sit tight on their positions,” said Qiu Zhicheng, a Hong Kong-based strategist at ICBC International Research Ltd. If foreign investors sell shares in Hong Kong amid concern about the downgrade, “It would be a good opportunity to buy on the dip.”

(Adapted from Bloomberg)

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Categories: Economy & Finance, Geopolitics, Strategy, Uncategorized

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