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In a world of below-zero bond yields, China debt bucks the trend

Tuesday, June 21, 2016 - 10:29

[HONG KONG] As investors drive bond yields across the world to record lows, China is going the other way.

The nation's 10-year government bond yield has risen 13 basis points this year to 2.95 per cent through Monday, the only increase among similar-maturity sovereign debt in the world's 15 biggest economies. Chinese bonds have sold off amid concern that rising inflation, stabilising growth and an overheating property market will halt further monetary easing.

Fidelity International and Insight Investment Management Ltd say investors are missing out on an opportunity to buy Chinese bonds at lower prices as the nation opens up its US$8.5 trillion market to foreign funds and a weakening economy triggers more stimulus.

The spread between China's yield and that of US Treasuries reached the widest in 10 months last week as concern over Britain's possible exit from the European Union boosted demand for havens.

"In the near term you may get slightly higher yields, but structurally you still have an economy that's on the gradual slowdown path," said Robert Simpson, a London-based portfolio manager at Insight Investment, one of the first batch of investors to register under a new program allowing interbank bond purchases without quotas.

China is a market that is "under-invested by foreign investors" and offers "positive real yields, which you don't really get in many places," Mr Simpson said.

Global government bonds are having their best start to a year in more than two decades amid concern the world economy is stalling, with 10-year yields falling below zero in Germany, Japan and Switzerland.

China's sovereign debt has slumped the most since 2009 in the same period. The yield on its 2026 notes rose three basis points Tuesday to 2.97 per cent, the most in two weeks.

Investors turned negative on the nation's bonds in January, after the 10-year yield dropped to a seven-year low, as a tumbling yuan fueled speculation the People's Bank of China would refrain from easing.

Consumer prices climbed 2.3 per cent in February, the fastest pace since mid-2014, amid a real estate boom in the nation's biggest cities. Adding to jitters, Moody's Investors Service and S&P Global Ratings cut their outlooks on China's credit rating in March. The central bank hasn't cut interest rates since October.

The nation is accelerating steps to open its bond market. In February, authorities removed quotas for medium- to long-term foreign institutional investors to buy interbank notes, and later eased rules on their currency exchange. Global funds still face restrictions such as a ban on onshore foreign-exchange trading, unclear tax rules and repatriation limits.

There's still room for further easing, with major banks required to hold 17 per cent of deposits in reserve, a relatively high rate compared with global peers. Inflation slowed to 2 per cent last month, while the recovery in the housing market that helped underpin the economy in the first half is showing signs of tapering off.

Easing concern that the currency will continue falling will also boost the appeal of Chinese debt to foreign investors, Mr Simpson said. The yuan will end the year 1.8 per cent below Monday's level, according to a Bloomberg survey, after sliding to a five-year low last week.

"It does appear in the short-term capital outflow pressure has receded somewhat, and I think for that reason people have become more comfortable in owning Chinese assets," he said.

Fidelity says it's actually a good thing that Chinese bonds are breaking ranks with the rest of the world.

Since August's yuan devaluation, overseas holdings of interbank Chinese government bonds have risen an average 1.9 per cent each month, compared with 3.6 per cent a month in the previous 12 months.

Foreigners held 296 billion yuan (S$60.47 billion) of those notes on May 31, just 3 per cent of the total.

"One of the nice things about the onshore Chinese market is it's not particularly correlated with developed markets," said Bryan Collins, a portfolio manager in Hong Kong at Fidelity, which managed US$272 billion in assets globally as of March 31.

"The grand scheme is to capture the correlation benefits and the total return expectations in the onshore bond market."

BLOOMBERG

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