What happened at China's 'Two Sessions' government meeting?

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 '13^th Five Year Plan.'

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.

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.

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.

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.