China’s unexpected decision to cut one of its key short-term policy rates is giving fund managers a reason to return to the nation’s bonds after trimming holdings every month this year.

The country’s sovereign debt looks attractive on growing signs policymakers will do more to shore up the economy, according to HSBC Asset Management. Further fiscal stimulus may set off a significant rally in the nation’s bonds, BNY Mellon Investment Management says.

The People’s Bank of China lowered its seven-day reverse repurchase rate to 1.9% on Tuesday from 2%, the first reduction since August, boosting speculation it will cut its key one-year loan rate on Thursday. Government bonds rallied after the decision, with 10-year yields dropping to the lowest since September.

“China’s onshore bonds will continue to benefit from the dovish trajectory of the PBOC,” said Sanjay Shah, director of fixed income at HSBC Asset Management in Singapore. “Given the recent depreciation that the renminbi had, we do think it has some value already and China is one of the markets which is quite attractive currently,” he said, using another name for the yuan.

China’s benchmark 10-year yield declined five basis points Tuesday to close at 2.62%, down from 2.84% at the end of December.

Tuesday’s policy easing is expected to be just the first of many as the authorities seek to bolster the faltering economy. China is weighing a broader package of stimulus proposals designed to support areas such as real estate and domestic demand, people familiar with the matter told Bloomberg this month.

‘Decent Rallies’

“We could see pretty decent rallies if you were to see some meaningfully policy stimulus depending on the policy mix,” said Aninda Mitra, head of Asia macro and investment strategy at BNY Mellon Investment Management in Singapore.

“The seven-day repo rate cut won’t, by itself, turnaround China’s macro prospects, it needs to be twinned with a much larger fiscal and regulatory easing,” he said. Still, “I’d be a bit wary about any short-term rally in government bond yields until the financing picture becomes clearer.”

BNY Mellon Investment Management, which oversees $1.9 trillion, is still tactically neutral on the nation’s debt — a position it has held all year — though it may consider putting money back into Chinese bonds if the yuan keeps weakening, Mitra said.

Weaker Yuan

One of the reasons overseas investors have been wary about investing in Chinese debt has been the weakening yuan. A Bloomberg index of the nation’s local-currency sovereign bonds shows foreign funds have made a loss of 0.3% this year, reversing a earlier gain of as much as 3.5% in mid-January, with the negative outcome reflecting the yuan’s decline.

The offshore yuan slid as much as 0.3% Tuesday to a seven-month low of 7.1789, driven by the outlook for additional stimulus.

Overseas investors cut holdings of Chinese sovereign bonds for a fourth straight month in April, trimming their positions by a combined 11.8 billion yuan ($1.6 billion), according to data compiled by Bloomberg.

Property Boost

Pinebridge Investments Europe Ltd. also forecasts additional stimulus, including for the troubled real-estate market.

“We expect some measures to be announced targeting the property sector directly,” said Anders Faergemann, head of emerging markets sovereigns at Pinebridge in London. “This may include relaxations in property purchase restrictions in higher-tier cities, which we view as critical to support high-yield property bonds.”

“This could also help reinvigorate the economy and make Chinese assets more broadly attractive again,” he said.

--With assistance from Malavika Kaur Makol and Ronojoy Mazumdar.