JPMorgan sees new normal in bonds as slowing China crimps yields

[HONG KONG] China's slowing economy will suppress global bond yields even as the Federal Reserve considers a rate increase, threatening returns for investors who rely on higher coupon payments, according to JPMorgan Chase & Co and Nomura Holdings Inc.

Average yields on bonds globally have dropped 8 basis points this quarter to 1.64 per cent, according to a Bank of America Merrill Lynch index. The decline comes after China's factory output slid to a three-year low and exports slumped. The International Monetary Fund said earlier this month that the global expansion outlook is worse than it anticipated, after China's US$5 trillion equity rout and currency devaluation sparked turmoil in global markets.

"As China's growth slows, returns on both global equity and fixed income may come down in the next few years because China accounts for a significant portion of global growth," said Ben Sy, the Hong Kong-based head of Asia fixed income, currencies and commodities at JPMorgan's private banking unit. "We will be facing a new normal of lower returns."

As Chinese Premier Li Keqiang likens managing the weakest growth since 1990 in the world's second-biggest economy to a "Chinese chess game," analysts have cut their forecast for global expansion to 3.1 per cent for this year from 3.4 per cent in 2014. Commodity prices have slumped to the lowest in 14 years, adding to a surge in corporate defaults to at least 65 after 60 for the whole of last year, according to Standard & Poor's.

"Since China is such a big part of global gross domestic product growth, slowing China will likely suppress both equity and fixed income yields," said Gaurav Singhal, credit analyst at Nomura in Hong Kong. China contributes about one third to global GDP growth, Bloomberg-compiled data show.

As the Fed meets this week to consider raising interest rates from near zero, it faces other central banks that have recently declined to do so.

Last week, the Bank of England decided to keep rates on hold, saying slower growth in Chinese demand, weak commodity prices and the prospect of Fed tightening will likely have an adverse effect on a number of emerging markets. The European Central Bank unveiled a revamp of quantitative easing recently, citing weaker global outlook.

Traders are pricing in an almost 60 per cent chance the Fed will raise interest rates in December, the first increase since 2006. Some 28 per cent say a rise could come as early as Thursday. Yields on 10-year Treasuries have dropped 17 basis points this quarter to 2.18 per cent.

Fitch Ratings Ltd expects China's trend growth rate to decline further as the country adjusts and rebalances. One scenario of gradual rebalancing could see the growth rate decline gradually to about 5 per cent on average in 2016-2020.

"Slower China growth means low growth globally," said Xia Le, the chief Asian economist at Banco Bilbao Vizcaya Argentaria SA in Hong Kong. "Combined with low real interest rate and low inflation, global bond yields will likely remain low."

BLOOMBERG