With housing woes hanging over the Chinese market - and the yuan on the weak side against a strengthening greenback - Chinese bonds are unlikely to find traction with foreign investors in the second half of 2022.
China’s debt market went through sell-off in the first half of 2022 amid risk-off sentiment for emerging markets investment caused by rate hikes, China's Omicron outbreaks, and geopolitical tensions.
Foreign investors’ holdings of Chinese debt shrunk to 2.6% of the total market versus 3.1% in January, standing at 3.64 trillion yuan ($538.87 billion) at the end of June.
In the government bond space, the outflow was intensified when the US-China yield gap turned negative in April for the first time since 2010 as the US entered a sharp rate hike cycle.
Currently, the 10-year Chinese government bond (CGB) is yielding at 2.75%, while the US 10-year Treasury yield is at a 2.67% level.
YUAN IS KEY FOR CGB
“A 2.5% to 3% yield is still attractive. But the negative factor is the depreciation of yuan,” said Tai Hui, chief market strategist, Asia Pacific at JP Morgan Asset Management.
In the first half of 2022, offshore Renminbi (CNH) depreciated 5% against US dollar.
But if investors become more confident in China’s economic recovery and less concerned about the geopolitical tensions going into 2023, and US Treasury yields start to fall and China’s to rise, Chinese government bonds may become more attractive to them, Hui said.
JP Morgan Asset Management anticipates the nominal US 10-year Treasury yield will end the year between 3%-3.25%, suggesting a modest move higher in long rates as the Federal Reserve reduces its balance sheet and inflation concerns linger.
Agreeing with Hui, Keiko Kondo, head of multi-asset investments, Asia at Schroders, noted that for offshore investors, the movement of local currency has a “much bigger impact” on their returns than the bond return itself.
“I think the challenge right now for international investors to consider buying Chinese government bonds on a hedge basis will be, eventually, everyone knows that the offshore market now offering pretty attractive yield, actually gives you better carry,” said Kondo.
"Then the CNH has been weak, and potentially I would argue that not just the CNH, but generally the Asian currencies are probably biased towards the weaker side in combination,” she continued.
“From the currency viewpoint, it's not a very strong story to be buying CGB … other than saying, OK, maybe diversification is based differently, but I think there’s a limit in terms of how much you can allocate,” she added.
NON-HOUSING CORPORATES STRONGER
JP Morgan’s Hui believes China’s corporate bonds could be more attractive than CGBs, however the entire property sector should not be considered due to liquidity risks, credit risks, and several other risk factors, including the housing mortgage woes that are still brewing.
“But if you look at market valuations or corporate credit spreads for non-property market-related companies, I think they are pretty resilient. Or rather, they're reflecting a low default risk,” Hui said.
"If investors are looking to invest in China's fixed income, the opportunities are still very much there …for non-property developers or quasi-government bonds, it's a pretty attractive way to generate income for investors,” he said.
That said, the overall sentiment for foreign investors to revisit corporate bonds in China is still not robust.
“This is more driven by negative news in the property sector than the macro environment,” said one Hong Kong-based head of institutional business for a North American fund house.
“There is just too much bad news in China’s property sector," the source said. "Although that bad news is only within one sector, China’s property sector is just too big and too influential to the overall financial market. So, investor sentiment towards the whole corporate bond space is not good.”
“For some China fixed income funds in the market, government bonds and corporate bonds are managed together. So, investors are just not investing in either of them,” the source added.
There are some family offices and private banks in Hong Kong that have started to revisit China fixed income funds, but haven’t made any investment yet, they said.