SCEPTICISM over Chinese assets is spreading beyond stocks, with investors expecting the yuan and government bonds to underperform in a year when the US Federal Reserve’s dovish pivot is set to buoy emerging markets.

Bearish sentiment towards China has intensified, as the latest data confirmed the world’s second-largest economy remains in the doldrums. While the gloom adds impetus for the People’s Bank of China (PBOC) to lower interest rates, investors say the monetary authority has less room to cut than its major global peers, whose borrowing costs are now at multi-year highs. 

“We expect the yuan to remain under pressure in the near term given the bearish expectations for China growth this year,” said Ken Cheung, chief Asian currency strategist at Mizuho Bank in Hong Kong. “Bonds will remain supported as the PBOC will maintain an easing bias. However, renewed yuan depreciation pressure and narrow net interest margin among Chinese banks will limit the room for rate cuts.”  

As China falls out of favour, traders see multiple reasons to be more positive toward its emerging market peers. Higher-yielding markets will have more room to gain from the Fed’s anticipated rate cuts, while South Korea and India’s potential inclusion into major global bond indices should give their assets an added boost.

Yuan’s relative weakness

Events over the past week have been a letdown for investors. Despite mounting calls for more stimulus, the PBOC kept its one-year policy rate unchanged, while Premier Li Qiang touted the nation’s ability to achieve economic expansion without resorting to massive stimulus, disheartening hopes for more policy support. 

While the new year sell-off in Chinese assets has mostly been concentrated in equities, continued foreign outflows will increase downward pressure on its currency. The offshore yuan has weakened more than 1 per cent this year, after dropping almost 3 per cent in 2023.

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“The yuan can weaken versus the basket of currencies of its trading partners which, for foreign investors, will offset most of the bond performance,” said Rajeev De Mello, a global macro portfolio manager at Gama Asset Management. “I prefer local currency bonds and currencies of countries where policy rates have been hiked preemptively, and where inflation is declining, with Brazil and Mexico standing out.”

JPMorgan Asset Management also sees a weakening bias in the yuan basket against trading partners in the first half of the year, and is looking for relative value opportunities, said Julio Callegari, chief investment officer of Asia fixed income. 

Economists expect the yuan will retrace some of its losses this year but will again underperform its Asian peers. Bloomberg surveys showed the US dollar-offshore yuan will fall 3.1 per cent to 6.99 by the end of December, compared with an average 4.4 per cent drop projected for emerging Asia ex-China pairs.

The yuan will be “quite an uninspiring currency” in this environment, where the US dollar is still strong, said Simon Harvey, head of foreign exchange analysis at Monex Europe in London.

Less attractive yields  

China’s government bonds have fared well so far this year, with yields falling as investors pinned their hopes on the PBOC’s easing. Yet, markets are increasingly searching for countries that offer higher yields, which stand to benefit once a shift to monetary easing kicks off. 

China’s benchmark 10-year yield is currently around 2.5 per cent, compared with more than 7 per cent in India, 9 per cent in Mexico and 10 per cent in Brazil.  

“We are underweight China bonds at this juncture, purely because the yields are higher in markets like India and Indonesia, while US Treasury proxies such as Korea bonds are attractive on the view that Treasuries have more upside from current levels,” said Edmund Goh, investment director of Asia fixed income at abrdn. 

South Korea’s 10-year yields are the most sensitive within emerging Asia to swings in similar-maturity Treasuries, according to a previous analysis by Bloomberg, making the notes a likely candidate to outperform when the Fed embarks on easing. BLOOMBERG