Global investors flock to Chinese bank bonds

Emerging market investors are betting that a ride in China’s bond markets is still in the works, even as Beijing signals growing discomfort with rising government debt.

China’s central bank has sought to calm a frenzy for long-term government bonds this year, led by local investors, which have pushed yields to about 2 percent, a response to weakened consumer demand in the world’s second-largest economy.

While foreign investors have reduced their direct holdings of Chinese government bonds in recent months, they have instead invested in short-term debt issued by Chinese banks and used currency transactions to raise total yields at rates above U.S. Treasuries, in terms of US dollars.

“From a fundamental, macro perspective, there’s still a lot of support for yields to come down,” said Mark Evans, Asian bond and currencies analyst at asset manager Ninety One. “There is very little inflation in the economy, no matter what you look at, and that reflects weak domestic demand. The real bond yield is quite attractive.”

Yields on China’s 10-year sovereign debt fell to 2.1 percent and those on 30-year bonds hit 2.3 percent as deflation worries dogged China’s economy following a housing market meltdown.

On paper, nominal yields that are well below US Treasuries in what is still a largely closed capital market should drive away overseas buyers. Foreigners hold about 2.2 billion lei ($300 billion) of Chinese government bonds, about 7 percent of the total, down from more than 10 percent three years ago, according to ChinaBond, a securities depository.

But Chinese onshore debt has remained relatively attractive to foreign investors, who can also earn an additional return from exchanging dollars for renminbi, which can be parked in bonds.

Overseas holdings of these negotiable certificates of deposit issued by Chinese banks rose to more than 1 trillion lei at the end of July, from about 260 billion lei a year ago, according to Shanghai Clearing House data.

“When you do a forward to hedge your exposure, it’s a pretty attractive yield increase,” currently about 4 percentage points on an annualized basis, on top of the underlying government bond yields, said Sabrina Jacobs, portfolio manager at Pict. Asset management. “That puts you in the region of 6%, in US dollars, for an asset class that is very uncorrelated with the US market.”

The slightly higher yields and shorter maturities of bank bonds made them even more attractive for these swaps. Over the past year, that debt has accounted for about two-thirds of net purchases of Chinese bonds by foreigners, who have meanwhile cut government debt to about half of their total holdings, according to analysts at Citic Securities.

The People’s Bank of China said it was prepared to intervene in the government bond market for the first time in decades to prevent a sharp decline in long-term yields amid fears that a possible snapback could trigger Silicon Valley Bank-style losses in the financial sector. system.

“They don’t like one-way expectations and they don’t like herd behavior given the risks to financial stability,” Evans said.

But some international investors say the central bank’s comments and potential intervention appear aimed at ensuring long-term bond yields don’t fall too far relative to short-term rates, rather than hampering the market as a whole.

The PBoC is focused on preventing an “asset-liability mismatch” with smaller lenders buying long-term bonds to park money from an influx of deposits as households save rather than spend or invest in property, it said Liam Spillane, Head of Emerging. market debt at Aviva Investors.

“The central bank is very transparent in its willingness to try to create a bit more two-way risk and volatility in the curve,” he said. “We don’t think they’re trying to push yields higher.”

The total outflow of foreigners from China’s government debt comes despite reforms in recent years that have made it easier for investors outside the mainland to buy such assets.

China has also been accepted into global benchmarks for local currency emerging market bonds, although it still has a relatively small weighting compared to its weighting in global stock indices.

“Unlike equities, where the exposure is over 20%, China is not moving the needle for emerging market fixed income investors,” said Malcolm Dorson, head of emerging market strategy at Global X ETFs. “There is not much downsides to ditching Chinese bonds at this time.”

But because Chinese government bonds have traded out of sync with other global debt markets in recent years, they have offered decent yields whether denominated in renminbi or hedged in other currencies, Jacobs said.

Finally, investors expect Chinese banks and other domestic investors to continue buying government bonds instead of lending to a slowing economy with little on the horizon to boost consumer demand.

Chinese policymakers in particular recently rejected an IMF proposal for a $1 trillion plan to reduce household property losses through government purchases of presold uncompleted housing stock. A bailout would violate “market-based and rule of law principles,” they said.

A drastic change in course is also unlikely while official growth targets are still being met, Evans said. “If GDP was growing at 3.5% instead of 4.5% or 5% right now, maybe they’d be a little more alarmed.”