Global investors are cutting their holdings of Chinese government bonds, a reliable source of secure returns during the pandemic years, as they get ready for some monetary tightening in China and eye more lucrative stock markets in the reopened economy.
China’s bond market was the outlier last year as global central banks hiked rates hastily to combat inflation, while policymakers in Beijing faced a sharp, COVID-induced downturn. But now, as the economy reopens rapidly, analysts expect the People’s Bank of China will eventually curb stimulus.
Signs of a peak in developed market rates are an additional reason why China’s bonds, yielding nearly 3% on 10-year investments, are less attractive, given the potentially higher capital gains elsewhere.
Data from China’s Bond Connect platform, the main avenue for foreigners investing in mainland markets, indicates foreigners sold almost 616 billion yuan ($90.63 billion) worth of bonds last year, reducing their holdings to 3.4 trillion yuan.
“If investors are saying that I want to trade the China recovery, the answer is not Chinese government bonds (CGBs). The answer to participating in risk-on opportunities in bonds would be Chinese offshore credit and long renminbi,” said Jason Pang, portfolio manager of the China Bond Opportunities Fund at J.P Morgan Asset Management.
Investors who have already committed cash to mainland markets might just shift to equities, he says.
Pang said he has partially cut his exposure to CGBs and reassigned a huge part of that into the offshore yuan (CNH) denominated dim sum bonds in Hong Kong. As global investors participate in China’s recovery through stocks in Hong Kong, cash conditions in the city will become better and put a floor under those bonds, he reckons.
In comparison to the global tightening trend, China has been loosening its monetary policy over the past two years. That has helped its bond market outrank peers.
The FTSE Xinhua Chinese Government Bond Index returned 3.2 percentage points last year in local currency terms and a minus 5.4 points in dollar terms. The FTSE World Government Bond Index (.FTWGBIUSDT) fell 18.3 percentage points in dollar terms.
Edmund Goh, head of fixed income for China at British asset manager abrdn, also favors nations that would be among the first to quit higher interest rates.
“We haven’t increased our Chinese bonds exposure in our Asian fixed Income portfolios as there are other markets that present a bigger upside in capital gains,” he said.
Markets such as India, South Korea, and Indonesia are likely to begin pricing in cuts as the next policy step, he added.
Jerome Broustra, head of investment specialists, fixed income and multi-asset solutions, core investments, at AXA Investment Managers, agrees with that view. He is heavy on Indonesian sovereign bonds and infrastructure-related offshore China high-yield bonds.
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The cushion of higher yields in CGBs has also vanished as U.S. yields first caught up and then outperformed China’s. Treasuries currently offer nearly 3.7% on 10-year tenors, while China’s equivalent is 2.9%. Meanwhile, the Shanghai stock market (.SSEC) rose 13% in just over two months.
“China bonds served as a very good type of diversifier, in particular over the past 3 years,” said Pang. But as global rates reach a peak, it seemed sensible to invest limited cash into better-yielding markets, he said.
Still, while fund managers are shifting to more attractive markets, they do not expect a huge selloff in CGBs.
“I don’t see a big trade in China’s local currency sovereign bonds, either in FX or in rates”, said Polina Kurdyavko, head of emerging markets and senior portfolio manager at BlueBay Asset Management.
“China’s central bank is much more adept to use administrative measures to direct liquidity in the pockets to where be most needed.”
Freddy Wong, head of Asia-Pacific fixed income at Invesco, thinks CGBs will bring in some inflows, especially as the yuan gains.
“A lot of global investors have been meaningfully under-allocated to China’s onshore markets. There might be potential interest, but I won’t rank that as a very high one,” said Wong.
($1 = 6.7969 Chinese yuan renminbi)
