South China Morning Post
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People wearing face masks walk past the headquarters of the People's Bank of China on April 4. The Chinese central bank’s conservative approach in its response to the economic impact of the Covid-19 pandemic could make it a darling for bond investors seeking higher yields. Photo: Reuters
Opinion
Kerry Craig
Kerry Craig

China’s bond market a potential hero for investors seeking yields

  • The People’s Bank of China has similar tools as other central banks but chose to use them more delicately than the sledgehammer approach of its peers
  • The relatively conservative nature of its support has increased the attractiveness of Chinese government bonds by creating a healthy spread over developed bonds
Kerry Craig
Kerry Craig
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Central banks have been both the heroes and villains of capital markets. Their actions have helped to support a V-shaped recovery in risk assets while further punishing income-seekers.

As markets start to fret about another wave of Covid-19 cases across Europe and the economic implications of renewed restrictions, they should perhaps be more concerned with the tsunami of liquidity that has squashed yields and the prospects for further easing of monetary policy in developed markets, thus compounding the income problem. There is still yield to be found, though, and China may be the new bastion for government bond investors.
Clouds have started gathering over the developed world as political uncertainty increases in the United States while Europe grapples with a resurgence in Covid-19 cases. While governments are loathe to reintroduce nationwide lockdowns, localised and sector-based restrictions may last for some time, restraining economic activity.

While some parts of the world are suffering from an economic stutter, China’s economic momentum continues to build. The supply side of the economy has made up lost ground from the shutdown earlier in the year, and indicators such as the growth rate of industrial production is the highest so far this year. The demand side is improving, too.

Chinese consumers have been slower to re-engage and did not benefit from big government cash handouts that many in the Western world did, but there are encouraging signs of increased household spending as retail sales are no longer falling in year-on-year terms. This is not to say the Chinese economy can receive a full bill of health, but its relative strength has important implications for income-seekers.
China’s policy response to the pandemic was very different to the rest of the world. The People’s Bank of China has similar tools as other central banks but chose to use them more delicately than the sledgehammer approach of the European Central Bank or the US Federal Reserve.

Perhaps wary of lessons learned after the 2008 financial crisis and the impact excessive gearing could have on financial stability, the PBOC has carried out a more balanced monetary policy. It has focused on targeted support to the real economy, avoiding the use of large-scale liquidity injections or interest rates close to zero.

This stands in sharp contrast to the foreshadowing of further easing by central banks elsewhere. The Fed’s new average inflation targeting framework pegs interest rates close to zero for years to come, and the Bank of England and the Reserve Bank of New Zealand are both toying with the idea of negative interest rates. Even the Reserve Bank of Australia, which has been relatively austere in its use of extraordinary policy, is signalling it may do more in the coming months to pin down bond yields.

The relatively conservative nature of the PBOC’s support, by comparison, has increased the attractiveness of Chinese government bonds by creating a healthy spread over developed bonds. Moreover, owning Chinese debt does not increase portfolio risk in the same way as owning broader emerging-market debt.

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What some investors may find surprising is that the Chinese government bond market has a low correlation to many global equity and fixed income benchmarks, adding a diversification benefit to portfolios. Chinese officials continue to focus on finding a balance between maintaining economic momentum while dialling back policy.

Such actions will continue to support government bond pricing, potentially positioning Chinese bonds as a relative haven for investors seeking an income hero.

However, there is the issue of access. The onshore bond market was comparatively inaccessible to outside investors until recently, but the inclusion of Chinese bonds in broad global benchmarks in the past two years is increasing their appeal.

Realignment of investors to the changes in global benchmarks will prompt a flow of passive money into the Chinese bond market, creating an additional form of support.

In a world swamped with liquidity and one in which central banks are prepared to show they have more to offer, those investors striving for something like a normal yield have to look beyond the usual suspects. The relatively high yield on Chinese government bonds, the potentially divergent paths in monetary policy and the broader inclusion in global bond indices make China’s bond market look downright heroic.

Kerry Craig is a global market strategist at JP Morgan Asset Management

This article appeared in the South China Morning Post print edition as: Why China may be new hope for government bond investors
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