China bond inflow surprise may be false dawn as PBOC hands tied

AN ABRUPT surge in foreign buying of Chinese bonds has raised hopes that pessimism about the nation’s assets may be overdone. But it may be too early to celebrate.

Global investors boosted their holdings in the world’s second-biggest debt market by 251 billion yuan (S$47.8 billion) last month, the second most on record according to China’s foreign exchange regulator. The increase was nearly six times October’s amount and puts yuan bonds on track to reverse last year’s record outflows of 616 billion yuan.

The surprise acceleration in inflows resulted more from a global bond rally as traders bet on an early and more aggressive switch to monetary easing by the US Federal Reserve, with demand also emerging from passively managed index-tracking funds. The momentum may slow, given Beijing’s constraints and lack of intention to loosen policy significantly, increased wariness of China’s long-term debt woes and the stronger appeal of cheaper emerging-market assets.

“Chinese bonds are unlikely to outperform other global bonds as the scale of monetary easing in the next six months would be larger elsewhere than in China,” said Kiyong Seong, lead Asia macro strategist at Societe Generale in Hong Kong. “I wouldn’t think it is sustainable.”

Foreign bond inflows were seen across Asia in November, suggesting that China also benefited from the broader trend, Seong added.

Cautious PBOC

The People’s Bank of China (PBOC) has cut its key policy rate twice this year but has stood pat since August, relying more on pump priming in money markets to spur economic growth. Top leaders also dashed hopes for big-bang stimulus at a policy meeting earlier this month.

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The US central bank’s policy tightening cycle has deterred the PBOC from adopting aggressive easing measures, given the pressure from a widening US-China rate gap on the yuan. Fed officials’ attempts in recent days to temper expectations for an imminent and sharp policy pivot mean the rate differential will unlikely narrow anytime soon.  

While theoretically a less hawkish Fed next year may open the door for further PBOC easing, the Chinese central bank’s policy rates are already at a record low. Beijing also may lack incentives to aggressively lower borrowing costs, given concerns about the effectiveness of its monetary loosening as credit growth and investment remains anaemic.

Worries about financial risks in the world’s second-largest economy, as highlighted in Moody’s Investors Service’s recent decision to cut China’s sovereign rating outlook, and persistent geopolitical tensions may also dampen global investors’ appetite for the country’s assets.

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The bond flow outlook for China in the next two years appears mixed, according to Morgan Stanley. Although most active investors who want to leave China have already exited, there’s a risk of additional capital flight from “sticky” funds as some are gradually switching their benchmarks from global or emerging-market bond indexes to an ex-China version, the bank’s analysts including Min Dai and Robin Xing wrote in a note.

Low yielders

In addition, the relatively low yields on Chinese bonds may also limit their appeal.

“When we are looking across EM at where we can receive rates, we see better opportunities in places like Mexico, Brazil and Korea for now, because we don’t think the PBOC is going to be that aggressively cutting interest rates,” said Manik Narain, head of emerging-market strategy research at UBS Group.

Some are slightly more upbeat.

Much of last month’s inflows stemmed from arbitrage opportunities, after a cash squeeze in China’s money market left yields on the country’s short-dated bonds higher than their US counterparts, according to Becky Liu, head of China macro strategy at Standard Chartered. “Given this window of opportunity still exists, we think December will also likely be a month of inflow.”

“We may see another round of rate cuts in China soon as the US dollar and rates are off the peak and global monetary policies are much more dovish than two months ago,” said Dongchen Wang, director and fixed income portfolio manager at Ping An of China Asset Management (Hong Kong). “Foreign inflows into RMB assets particularly bonds will continue next year.” BLOOMBERG