Foreign investors pile into Chinese onshore debt markets in search of yields as coronavirus pandemic worsens
- Yields on 10-year Chinese government debt have greatly exceeded US 10-year Treasury notes, similar government debt this year
- Foreign investors held US$319 billion in Chinese onshore debt as of end of March
Fixed-income investors are piling into yuan-denominated government debt at a record rate this year as they seek a safe haven amid the coronavirus pandemic, which threatens to send the global economy into a downturn not seen since the Great Depression, according to analysts and investment managers.
At the end of March, global investment funds and overseas investors held 2.26 trillion yuan (US$319 billion) in Chinese onshore debt, according to Bond Connect Company, the operator of the three-year-old Bond Connect programme, which allows qualified foreign investors to buy Chinese bonds without setting up an onshore business. That was a slight decrease from a record 2.28 trillion yuan at the end of February. Overseas investments in Chinese debt rose 28 per cent in the first quarter on a year-on-year basis. Foreign investors, however, remain a small percentage of the US$14 trillion onshore bond market in China.
Jerry Li, head of Greater China local markets at Deutsche Bank, said there has been less “market noise” in China than international bond markets over the pandemic.
“We have been through a big rally in international fixed-income markets [followed] by a big sell-off when liquidity dried up in these dollar bond markets,” Li said. “If you look at the China bond market, we actually see relatively low volatility and better liquidity compared with the dollar bond markets.”
The new coronavirus, known as SARS-CoV-2, has infected more than 2.1 million people worldwide and forced near shutdowns in major cities – from New York to Singapore – around the globe.
The International Monetary Fund said last week that the global economy was very likely to experience its worst recession since the Great Depression, outpacing the downturn during the global financial crisis in 2008.
China’s economy contracted by 6.8 per cent in the first quarter as a result of widespread shutdowns over the coronavirus. That marked the first time the country’s economy shrank since the government began reporting quarterly gross domestic product growth nearly four decades ago.
However, the government is expected to undertake additional fiscal stimulus to boost the economy, which might ultimately fare better than other major economies around the world over the course of the year, according to investment manager Invesco.
“China is likely the only major economy that will squeak out positive GDP growth for 2020,” David Chao, global market strategist for Asia-Pacific, excluding Japan, at Invesco, said. “Whether that will be 1 per cent or 3 per cent is very much dependent on the government’s policy – specifically any additional fiscal stimulus packages that will drive growth in the second half.”
As the pandemic halted many economies around the world, monetary policymakers pushed interest rates to historic lows, including negative rates in Japan and parts of Europe. That sent bond yields down dramatically. Yield on the 10-year US Treasury, for example, dropped by 95 basis points from mid-February to end Friday at 0.64 per cent.
Despite dropping to a record low of 2.47 per cent this month, Chinese 10-year government bonds continue to have a much higher yield than Treasuries or similar government debt. On Friday, Chinese 10-year yields stood at 2.55 per cent.
Foreign investors in yuan-denominated bonds primarily focused on Chinese government debt and bonds issued by China’s so-called policy banks, China Development Bank, Export-Import Bank of China and Agricultural Development Bank of China, according to analysts.
Private sector companies in China could also face refinancing risks down the road, according to S&P Global Ratings. Many firms turned to the domestic debt markets for short-term relief after they were squeezed this year by a liquidity crunch in offshore dollar bond markets.
“Most new issuance is short term, adding to already high maturity walls over the next two years,” Chang Li, China country specialist at S&P Global Ratings, said. “Moreover, continued borrowing amid low demand is likely to increase corporate leverage.”
Despite the challenges to the private sector, government debt and policy bank bonds are likely to remain attractive to foreign investors in the coming years, as more Chinese debt is included in global bond indices.
Last April, Bloomberg began phasing in yuan-denominated government bonds and policy bank securities to its US$54 trillion Bloomberg Barclays Global Aggregate Index over a 20-month period. JPMorgan Chase began adding Chinese government debt to its indices at the end of February.
Since the Bloomberg Barclays inclusion last year, US$69 billion in foreign money has streamed into Chinese domestic bond markets, with about a third of these inflows coming since the end of September.
Hayden Briscoe, head of fixed income for Asia-Pacific at UBS Asset Management, said the inclusion of Chinese debt will represent the “single largest change in capital markets in anybody’s lifetime” as central banks, sovereign wealth funds and index trackers move to reach index weight. Between those three groups, it would potentially represent US$3 trillion in inflows, he said.
“The last six months, that’s just the start of things to come,” Briscoe said.
