Global investors are reducing their holdings of Chinese government bonds, a steady source of secure returns during the pandemic years, as they prepare for some monetary tightening in China and eye juicier stock markets in the reopened economy.
China’s bond market was the outlier in 2022 as global central banks raised rates hurriedly to fight inflation, while policymakers in Beijing faced a sharp, COVID-induced slowdown. But now, as the economy reopens swiftly, analysts expect the People’s Bank of China will eventually rein in stimulus.
Signs of a peak in developed market rates are another reason why China’s bonds, yielding roughly 3% on 10-year investments, are less appealing, given the potential greater capital gains elsewhere.
Data from China’s Bond Connect platform, the primary avenue for foreigners investing in mainland markets, shows foreigners sold roughly 616 billion yuan ($90.63 billion) worth of bonds in 2022, taking their holdings down to 3.4 trillion yuan.
That trend has strengthened this year, as per fund managers.
“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 switch to equities, he says.
Pang said he has partially reduced his exposure to CGBs and reallocated a large part of that into the offshore yuan (CNH) denominated dim sum bonds in Hong Kong. As global investors play China’s recovery through stocks in Hong Kong, cash conditions in the city will improve and put a floor under those bonds, he reckons.
In contrast to the global tightening trend, China has been easing monetary policy over the past two years. That has helped its bond market outperform peers.
The FTSE Xinhua Chinese Government Bond Index returned 3.2% in 2022 in local currency terms and a negative 5.4% in dollar terms. The FTSE World Government Bond Index declined 18.3% in dollar terms.
Edmund Goh, head of fixed income for China at British asset manager abrdn, also favours countries that would be among the first to exit 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 South Korea, India and Indonesia are likely to start 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, shares that view. He is overweight Indonesian sovereign bonds and infrastructure-related offshore China high yield bonds.
YIELD ADVANTAGE SHRINKS
The cushion of higher yields in CGBs has also evaporated as U.S. yields first caught up and then overtook China’s. Treasuries now offer around 3.7% on 10-year tenors, while China’s equivalent is 2.9%. Meanwhile, the Shanghai stock market is up 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 hit a peak, it made sense to plough limited cash into better yielding markets, he said.
Still, while fund managers are switching to more attractive markets, they do not expect a massive 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 is most needed.”
Freddy Wong, head of Asia-Pacific fixed income at Invesco, believes CGBs will attract some inflows, particularly as the yuan gains.
“A lot of global investors have been meaningfully under-allocated to China onshore markets. There might be potential interest, but I won’t rank that as a very high one,” said Wong.