Debt Managers Spring Back Into China With U.S. Rates Stalling
(Bloomberg) -- Chinese debt is back in favor with overseas investors.
After the nation’s government bonds suffered their first outflow in two years in March, foreigners added 52 billion yuan ($8.1 billion) to their holdings in April, bringing the total to a record 2.1 trillion yuan, data compiled by ChinaBond show.
In a game-changing shift -- compared by some to the birth of the euro -- yuan-denominated debt has emerged as a refuge during this year’s global bond rout. Investors looking for diversification have piled in, seeking its relatively high yields and low correlation to other markets. While that partially reversed in March, as rising U.S. yields dimmed Chinese bonds’ appeal, the quick turnaround has underscored the resilience of demand and China’s growing clout since opening its fixed-income market.
“The underlying case for Chinese bonds is still very, very strong,” said Pramol Dhawan, head of emerging markets portfolio management at Pacific Investment Management Company LLC. “Because of its low correlation to global rates, its high nominal yields and high real yields form a very important part of portfolio construction.”
Foreign investment in China’s interbank fixed-income market, as compiled by ChinaBond, rose 65 billion yuan in April to an all-time high of 3.2 trillion yuan, the data showed. Those holdings more than doubled over the past two years as Chinese bonds were included in global benchmarks compiled by Bloomberg Barclays and JPMorgan Chase & Co. Still, foreign investors only account for 4.3% of the total debt in China’s interbank market.
“We are increasing our exposure to the Chinese bonds,” said Kheng Siang Ng, Asia Pacific head of fixed income at State Street Global Advisors. “It’s hard for the markets to ignore.”
Even as foreign investors returned, the April numbers suggest the momentum of inflows has slowed from the breathtaking pace earlier this year. Last month’s inflow was less than half the amount seen in January.
The yield premium of China’s benchmark 10-year bond over Treasuries narrowed by around 1 percentage point to about 154 basis points from a record in November. On top of that, FTSE Russell said in March that it will take three years to add Chinese debt into its global index, instead of the 12 months initially envisioned. That disappointed some investors who expected a faster inclusion.
Nick Maroutsos, head of global bonds at Janus Henderson Investors, is among those who aren’t yet ready to buy Chinese bonds.
“We get asked this a lot, and my answer to whether we own or will own Chinese bonds is, ‘Not right now,’” said Maroutsos, whose firm managed more than $414 billion as of March.
“Ultimately, we are defensive buyers, and I have a hard time looking at emerging markets as a safe haven for investors,” he said. “Chinese government bonds aren’t going to protect you and won’t behave in a manner similar to Treasuries.”
China’s bonds have been dancing to their own tune, in part because they are less owned by foreign investors, and China’s independent economic and policy cycles set them apart from the rest of the world.
Over the past 10 years, their correlation with the U.S. Treasuries was less than 0.2, according to a Bloomberg analysis. Yields on 10-year Chinese bonds were little changed this year, while equivalent Treasury yields surged 69 basis points.
Read More: Carry Trades in China, Korea Are Best in Low-Yield Covid Era
While the yield spread has narrowed, at 3.1%, China’s 10-year yield is almost double that of Treasuries. Even if U.S. yields rise further, Chinese bonds remain appealing because of their low correlation to global markets, which helps investors lower volatility in their portfolio, said Lucy Qiu, a strategist at UBS Global Wealth Management.
“Investors still need to look for uncorrelated sources of returns, as negative bond-equity correlations may be challenged during a rapid rise in yield,” Qiu said.
©2021 Bloomberg L.P.