Global investors are reducing their holdings of Chinese government bonds, a steady source of safe yields during the pandemic years, as they prepare for some monetary tightening in China and explore juicier stock markets in the reopened economy.
China’s bond market was the exception in 2022, when global central banks rushed up rates to fight inflation at a time when Beijing’s policymakers were facing a sharp COVID-induced slowdown. But now, as the economy reopens rapidly, analysts expect the People’s Bank of China to eventually reduce stimulus.
Signs of a spike in developed-market rates are another reason why Chinese bonds, which yield about 3% on 10-year investments, are less attractive, given the potential for higher capital gains elsewhere.
Data from China’s Bond Connect platform, the main avenue for foreigners to invest in mainland Chinese markets, shows foreigners sold bonds worth about 616 billion yuan ($000.90 billion) in 630, reducing their holdings to 2022.3 trillion yuan.
This trend has reinforced this year, according to fund managers.
“If investors say they want to trade in China’s recovery, the answer is not Chinese government bonds (CGBs). The answer to engaging in bond risk opportunities would be offshore Chinese credit and long positions in the renminbi,” said Jason Pang, portfolio manager at J.P. Morgan Asset Management’s China Bond Opportunities Fund.
Investors who have already committed cash in continental markets could switch to equities, he says.
Pang says it has partially reduced its exposure to CGBs and reallocated much of it to yuan-denominated dim sum bonds for international markets (CNH) in Hong Kong. As global investors become part of China’s recovery through Hong Kong securities, liquidity conditions in the city will improve and put a floor under those bonds.
In contrast to the global trend towards tightening, China has relaxed its monetary policy over the past two years. This has helped its bond market outperform its peers.
The FTSE Chinese Government Bond Index returned 3.2% in 2022 in local currency and negative 5.4% in dollar terms. The FTSE World Government Bond Index was down 18.3% in dollar terms.
THE YIELD ADVANTAGE IS REDUCED
The higher yield cushion of CGBs has also evaporated as U.S. yields first caught up with and then surpassed China’s. Treasuries now offer around 3.7% at 10 years, while the Chinese equivalent is 2.9%. Meanwhile, the Shanghai stock market is up 13% in just over two months.
“Chinese bonds have been an excellent diversifier, especially in the last three years,” says Pang. But now that global interest rates have rebounded, it makes sense to invest limited cash in markets with better yields.
Still, while fund managers are shifting to more attractive markets, they don’t expect a CGB sell-off.
($1 = 6.7969 yuan Chinese renminbi)