The pandemic has been speeding otherwise slow changes in the Chinese bond market. Inflows are accelerating, as China successfully contains the virus domestically, emerging as the only major economy forecast to have positive full-year GDP growth. A divergence in policy responses by Washington and Beijing has also raised the appeal of Chinese onshore bonds. The fact that the US has undertaken aggressive monetary and fiscal stimulus over recent months and China has not, has created a number of key factors for investors to consider.
First, a weak dollar and a stronger-than-expected renminbi are persuading more global funds to boost their allocation to Chinese assets. Second, a widening yield spread of Chinese bonds over American securities of similar quality and maturity is adding to the incentive of investing in China.
Third, the relative restraint exercised by the People’s Bank of China means that the Chinese bond market can function normally, offering a good way to diversify from global risks. The Fed has signalled that rates will stay near zero through 2023, as the economy takes time to return to its previous strength. China, on the other hand, has surprised many by resisting the temptation to flood its economy with cheap credit.
When global fixed income investors scrambled for cover in panic selloffs in March, China’s onshore bond market offered a rare haven with low volatility and no liquidity crunch. As capital controls are loosened and foreign inflows gradually rise, the Chinese market will become more correlated with the rest of the world. But until a critical mass is reached, the country’s diversification benefit for global investors will remain.
China’s quick “first in, first out” recovery from the pandemic has set the stage for a strong rebound in economic activity. Tens of millions of people toured around China in an eight-day national holiday through Oct. 8, while much of the world remained under tight travel curbs.
There is plenty of room for growth in foreign participation, as money from overseas accounts for only around 3 per cent of China’s $14 trillion onshore bond market, far below levels of 10 per cent and above for Asian neighbours like Japan and South Korea. Chinese government bonds (CGBs) have captured most inflows to the country, while the foreign presence in the corporate segment is still negligible due to a lack of inclusion in global indexes.
But the floodgate has opened. Global index compilers have been adding CGBs as well as bonds issued by Chinese policy banks, following the launch of cross-border trading links in recent years. The Chinese Interbank Bond Market and the Bond Connect programmes have both widened access for foreign institutional investors.
While foreign investors still face restrictions on security types, hedging and repatriation of funds, I expect cross-border trading rules to ease further in the foreseeable future. There is a high chance that overseas institutions will be allowed to trade CGB futures, although derivative products, which are scarce for locals as well as foreigners, will likely remain off the menu.
On the geopolitical front, tensions with Washington have prompted Beijing to speed up the opening of its financial markets to global capital. Efforts to promote broader international use of the renminbi should also boost inflows to Chinese onshore bonds.
Unlike digital acceleration, the rise of China’s fixed income market is evolving with little fanfare. But the potentially seismic shift is firmly underway, with huge implications for the landscape of global fixed income investments.
A version of this article was first published in The Business Times.