South China Morning Post
Advertisement
Advertisement
A man pushes a bike past the PBOC building in Beijing on March 4. The low cost of borrowing in China’s money markets suggests the central bank has room to tighten policy by withdrawing liquidity from the financial system -- like it did in January. Photo: Bloomberg
Opinion
Macroscope
by Neal Kimberley
Macroscope
by Neal Kimberley

Inflation worries add to the appeal of Chinese government bonds for investors

  • Chinese government bond yields are not only higher than the yields for other government paper, their relative lack of volatility is also an attraction
  • With Western central banks intent on keeping their policy settings loose, despite the risk of inflation, the PBOC’s more balanced approach is reassuring
Neal Kimberley
Neal Kimberley
Why you can trust SCMP

“Inflation is the tiger whose tail central banks control,” said Bank of England chief economist Andy Haldane last month. But you can’t grasp the tiger’s tail if you don’t or won’t see the tiger. Western central banks seem unable or unwilling to accept that inflation is a potential problem. China’s central bank appears more clear-eyed.

Bond market investors may choose to place their faith in the People’s Bank of China if they are seeking greater assurance that the value of their capital will be protected. Capital flows are already China-bound and overseas investors bought another US$14.78 billion worth of Chinese bonds on a net basis in February, according to calculations by Reuters.

The yields appeal. While the 10-year Chinese government bond was yielding some 3.26 per cent on Friday, the yields on equivalent 10-year UK and US government paper were 0.8 per cent and 1.6 per cent respectively. And even those were more attractive than the minus 0.3 per cent yield on 10-year German government paper.

But it’s not just the absolute level of the yield that appeals, it’s the relative lack of volatility in the 10-year Chinese government bond space. The yield on the 10-year bond has been in a tight range over the past month, even amid heightened volatility in other 10-year sovereign bond markets.

Workers walk through a construction site in the central business district in Beijing on March 8. Investors’ faith in Chinese government bonds is high and growing. Photo: AP

From a bond investing perspective, as opposed to a bond trading viewpoint, there’s nothing more alluring than a decent yield coupled with a lack of market volatility.

That’s especially so when, as in this case, the renminbi continues to hold its own on foreign exchanges, enabling investors to feel more comfortable that the value of interest earned in renminbi from Chinese government bonds will not be eroded when measured in their home currency terms.

Leaving aside any argument that the world is underweight in China and needs to address that fact, given how significant a component of the world economy it now represents, these bond investment flows still require investors to have confidence in Beijing’s monetary policy settings.

As it stands, the PBOC is seeking to rein back credit growth so as to contain debt risks, while ensuring struggling small firms can still access adequate support. Admittedly, new bank lending in China fell less than expected in February from January, but to the extent that the Chinese central bank still wants to see the pace of credit growth slow, the PBOC may well opt to do more to achieve its aims.
After all, as Premier Li Keqiang affirmed at the National People’s Congress, the government “will give even greater priority to serving the real economy, and balance the needs of promoting economic recovery and preventing risks”.

“We will see that increases in money supply and aggregate financing are generally in step with economic growth in nominal terms, maintain a proper and adequate level of liquidity supply, and keep the macro leverage ratio generally stable,” Li said.

Investors will be well aware that such an even-handed approach stands in marked contrast to current policy settings elsewhere.

Notwithstanding that the yields on both 10-year French and German government bonds remain in negative territory, uncertainty about the near-term economic outlook for the euro area prompted the European Central Bank to announce last week that it now expects asset purchases under its €1.85 trillion (US$2.2 trillion) pandemic emergency purchase programme “over the next quarter to be conducted at a significantly higher pace than during the first months of this year”.

Clearly the ECB is not concerned about running into any “inflation tiger” any time soon.

Meanwhile in the US, in the run-up to Wednesday’s policy-setting Federal Reserve Open Market Committee, and even with the roll-out of the US$1.9 trillion fiscal stimulus, Fed officials have exhibited few, if any, concerns about heightened risks of price inflation.

UK monetary policy also remains ultra-accommodative but at least policymakers such as Haldane are starting to consider inflation risks. While acknowledging that “people are right to caution about the risks of central banks acting too conservatively by tightening policy prematurely”, Haldane nevertheless feels “the greater risk at present is of central bank complacency allowing the inflationary (big) cat out of the bag”.

Haldane is right, but so committed are Western central banks to ultra-accommodative policies that it’s hard for them to even acknowledge that an “inflation tiger” may be lurking around the corner, let alone grab its tail.

Western central bank monetary policy settings currently give little comfort to bond investors who have concerns about an “inflation tiger”. For such investors, Chinese government bonds may look a good refuge from such tigers.

Neal Kimberley is a commentator on macroeconomics and financial markets

1