(Bloomberg) – Overseas funds returned to selling Chinese bonds in January after a month-long pause, underscoring the relatively unattractive yields on yuan bonds as Beijing keeps monetary policy loose to support growth.
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Foreign holdings of Chinese onshore interbank bonds, including government bonds, political bank bonds and other fixed income securities, fell 106.5 billion yuan ($15.5 billion) to 3.28 trillion yuan, the lowest since 2020, according to Bloomberg calculations based on data from the China Central Depository & Clearing Co. and Shanghai Clearing House. This is also the largest outflow since May.
The figures had been eagerly awaited as December data showed that foreign investors had increased their holdings of Chinese bonds following record outflows for most of last year. Global funds are watching how the country’s debt and yuan react to the country’s reopening from Covid Zero and the monetary policy outlook as the central bank seeks to support the recovery.
There are a number of positives for Chinese bonds this year, including an improving economy that could boost sentiment towards the country’s assets, while being an index component they could benefit from passive capital flows amid a recovery in global debt. On the downside, they could face the risk of asset rebalancing as investors seek higher-yielding assets, while political divergence between China and the US dampens demand for the Asian country’s securities.
Index replication and reserve allocation inflows into China bonds should resume this year, but active investment flows are unlikely to return until the negative yield gap of Chinese bonds versus government bonds turns positive or the yuan strengthens, said Linan Liu, head the Greater China Macro Strategy at Deutsche Bank AG in Hong Kong. The outflows are likely to continue until foreign demand picks up in the second half, which should help boost the annual inflow to 250 billion yuan, she said.
yield divergence
China’s 10-year bonds are yielding 2.89%, compared to 3.81% for similar-maturity US Treasuries. This yield discount was a factor that prompted foreign investors to reduce their holdings of the country’s government bonds by 66.3 billion yuan last month.
Abrdn is positive on China’s five-year bond but short 30-year debt, based on expectations that economic reopening will be accompanied by accommodative monetary and fiscal stance, said James Athey, investment director of rates management at the money manager in London.
Chinese bonds may continue to be a symbol of stability in 2023 without currency hedging, but “as we anticipate recession and eventual rate cuts in the rest of the world, we see higher yielding and more attractive duration opportunities in bonds like the US and Mexico,” he said.
‘Start nibbling’
Some investors are waiting for a better entry point to buy the country’s bonds, and that could come as yields rise as reopening translates into faster economic growth and inflation.
If the 10-year yield climbs to around 3%, “we’re likely to start nibbling around those levels again” to take advantage of volatility, said Brad Gibson, head of Asia Pacific fixed income at AllianceBernstein in Melbourne.
The resumption of foreign capital outflows in January reduced the share of Chinese onshore government bonds held by foreign investors to 8.8%, down from 11.1% a year ago. The proportion of interbank bonds held by global funds also fell to 2.6%.
“Strong diversification”
While that may disappoint Chinese officials who have been scrambling to open up onshore markets to the world, the country’s relatively low level of foreign ownership means the country’s bonds may be less correlated with major global markets.
“The market continues to be dominated by domestic investors, including Chinese banks, pension funds and mutual funds,” said Desmond Soon, head of investment management for Asia ex-Japan and fund manager at Western Asset Management Co. in Singapore. The low sensitivity of Chinese government bond yields to global interest rates has demonstrated their “strong diversification attributes within a global government bond portfolio – and we believe the low correlation will persist,” he said.
–Assisted by Tania Chen.
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