Bullish China Bond Investors Debate How Far Rally Can Run

Foreign investors are sticking with their bullish views on Chinese debt after Beijing’s dovish tilt, though most see the current rally as more-or-less done.

JPMorgan Asset Management, Fidelity International and Pictet Asset Management don’t see benchmark yields falling much further than 2.9%-3.0%, but see the bonds as attractive due to their low correlations with the rest of the world and premium to peers. UBS Asset Management is more bullish, saying China’s 10-year yield -- which has fallen to a 12-month low of 2.93% after Beijing’s shift toward monetary easing last week -- could drop as much as 100 basis points to a record if officials cut rates this year.

China’s government bonds have defied expectations of a selloff all year, as global investors snapped up the debt to take advantage of their yield premium over the rest of the world and the potential for the yuan to strengthen. Foreign funds were net buyers of onshore sovereign notes in all but one month since the start of 2020, pushing holdings to an unprecedented level in June.

Bullish China Bond Investors Debate How Far Rally Can Run

The spread between China’s benchmark bond and the U.S. equivalent has narrowed to 153 basis points from a high of over 250 basis points in November. The 10-year yield on Chinese sovereign notes climbed one basis point to 2.93% on Wednesday afternoon in Asia. On Thursday, the nation will release economic data including second-quarter gross domestic product, along with June retail sales and industrial production.

Here’s what a selection of foreign fund managers are saying about Chinese bonds:

Julio Callegari (Portfolio manager, JPMorgan Asset Management)

  • Structural factors, such as global index inclusion of Chinese bonds, will justify foreign participation, and that will not be altered by Beijing’s dovish tilt
  • A slightly more dovish monetary stance may increase the foreign interest marginally
  • Given China’s reserve ratio cut is “measured,” the country’s 10-year yield will not drift much lower than 2.9%
  • The yuan will trade around current levels versus a basket of currencies
  • The cut in reserve-requirement ratio isn’t a change in policy, as deleveraging remains a priority
  • “The RRR cut reflects policy makers’ efforts to support the Chinese economy amid recent signals of growth moderation and stress in parts of the credit market,” he said. “An RRR cut shows that policy makers are cognizant of the risks and will act to prevent any major deceleration.”

Morgan Lau (Fixed-income portfolio manager, Fidelity International)

  • China’s 10-year yield won’t go much lower than 3%, and will be range-bound in the medium term
  • “It’s always a good time to buy” when the yuan is stable and the 10-year bonds yield around 3%
  • The People’s Bank of China is unlikely to roll over the 400 billion yuan of medium-term lending facility that will come due on Thursday
  • China will watch market reactions before making more easing moves; it may give window guidance to banks, such as asking them to lend more to smaller and medium companies and limit lending to each other in the interbank market
  • The PBOC’s attitude toward its monetary stance hasn’t changed -- it is still cautious
  • “If we see economic situations change or more Covid-19 resurgence in China, we could potentially see a rate cut,” he said, adding that monetary easing that’s not targeted could induce inflation and a wider wealth gap

Cary Yeung (Head of China debt, Pictet Asset Management)

  • “Foreign investors will continue to show interest in Chinese bonds given its de-correlated nature with global asset classes that bodes well for diversification”
  • “In addition, China bond yields is still high relative to developed markets’ bond yields especially under the contained inflation pressure of China”
  • Bond yields will stabilize at current level in the absence of a surprise on economic data
  • The RRR cut is a “minor” adjustment of monetary policy by PBOC in response to the moderation of economic recovery
  • Yuan appreciation may take a breather in the near term; In the longer run, the currency is still supported by solid exports, continuous inflow into China’s capital markets and the limitation on outbound traveling

Hayden Briscoe (Head of fixed income for Asia Pacific, UBS Asset Management)

  • Foreign investors will keep buying Chinese bonds, which “tick all the boxes,” including their low correlation with notes sold in other nations and their high yields
  • China will want to see its government bonds’ yield premium over the U.S. Treasuries narrow, as that will take some appreciation pressure off the yuan
  • Movements in Chinese bonds are leading the world by six to 12 months
  • China will likely ease further to support growth; PBOC will likely reduce the benchmark lending rate by the end of this year
  • Yield on 10-year government bonds will fall by at least 25 basis points in coming three months; it could decline by 50-100 basis points if China cuts rates

©2021 Bloomberg L.P.

BQ Install

Bloomberg Quint

Add BloombergQuint App to Home screen.