China’s bonds emerge as the surprise sanctuary while the world’s debt market retreats

PUBLISHED : Wednesday, 25 April, 2018, 11:39am
UPDATED : Wednesday, 25 April, 2018, 11:39am

China’s debt challenges were so bad its economy was supposed to be on the infamous treadmill to hell. And many expected the country’s efforts to rein in financial leverage to undermine demand for bonds.

So it may come as some surprise that Chinese bonds are the top performers so far this year, among 70 markets in the Bloomberg Barclays Global Aggregate + China index, calculated in dollars. Other measures show the gain for yuan government and corporate debt, at nearly 2 per cent, is almost a mirror image of US bonds’ 1.6 per cent drop.

While the rally in Chinese bonds -- spurred in part by authorities’ shift in recent weeks to support liquidity -- has eroded their yield premium, it’s also showcased the value of the securities as a diversification play. That’s all the more important as China increasingly opens up its US$12 trillion bond market, the world’s third largest, to foreign investors.

“As the onshore market is now quite accessible, foreign inflows are likely” to keep pouring in, said Frances Cheung, head of Asia macro strategy at Westpac Banking in Singapore. “The narrowed China-U.S. yield differentials may not be a hindrance,” given the diversification attraction, she said.

While US Treasury yields have been climbing, thanks to prospects for further Federal Reserve interest-rate increases and concerns that inflation will finally pick up, in China, policymakers are signalling less-abrupt moves to address financial leverage. A gathering of the Communist Party’s Politburo this week highlighted the need to expand domestic demand, and press for the development of the nation’s financial markets. Stocks applauded Tuesday.

“Global investors are still keen to get involved even after the rally,” said Robert Subbaraman, Singapore-based head of emerging markets economics at Nomura Holding. ”China is going to be a lot more stable“ than other emerging markets, he said, as economies round the world cope with diminished monetary stimulus from developed-nation central banks.

Allianz Global Investors Singapore and Neuberger Berman Group LLC are among those looking to bulk up their China holdings. Foreigners now hold 1.8 per cent of the nation’s 75.9 trillion yuan (US$12 trillion) debt, up from 1.6 per cent at the end of last year.

Chinese notes in the Bloomberg index have climbed 6.2 per cent this year, versus a gain of 4 per cent in Japan’s bonds, the second-best performer in the gauge which measures dollar returns of investment grade notes in both developed and emerging markets. When removing the currency effect, Chinese debt is also the best performer, contributing positive returns to the index which registered a loss of 0.85 per cent, data compiled by Bloomberg show.

“Overseas institutions became the biggest winner in China’s sovereign rally as they expanded their positions quickly since the third quarter,” said Shan Kun, Shanghai-based head of local markets strategy at BNP Paribas. “With more investors starting to pay attention to the market, we don’t expect them to slow their pace of purchase by much.”