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Chinese fixed income – The new frontier for global bond investors

Despite increases in foreign holdings in every quarter over the past three years, only 2.4%* of China’s vast domestic bond market — the world’s second-largest — was owned by foreign investors as of the end of June, according to Moody’s. Jean-Charles…

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3 years ago

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Despite increases in foreign holdings in every quarter over the past three years, only 2.4%* of China’s vast domestic bond market — the world’s second-largest — was owned by foreign investors as of the end of June, according to Moody’s.

Jean-Charles Sambor, head of global emerging market debt, explains why Chinese fixed income offers unique opportunities to global bond investors.

  • In today’s world of negative bond yields, China’s onshore fixed income markets really stand out, offering nominal yields above 3% for 10-year government bonds
  • Besides offering diversification via a relatively low correlation with other asset classes, Chinese onshore fixed income is denominated in renminbi (RMB), a currency that stands to benefit from strong inflows as it gains its place among the world’s reserve currencies
  • Chinese bonds offer strategic exposure to long-term trends such as the inclusion of China in global bond benchmarks, the growth of China’s pension industry, and of course China’s status as one of the world’s largest economies.

Why are Chinese bonds so important for global bond investors?

Firstly, with outstanding issuance of around USD 14 trillion, China is now the world’s second largest sovereign bond market. As such, global bond investors simply cannot afford to ignore it. Funds tracking global bond benchmarks are increasingly incorporating Chinese bonds. Chinese fixed-income instruments will inevitably become more prevalent in international investors’ portfolios. This process is underway but, in my opinion, it has much further to run.

In addition, in an environment where fixed income investors are starved of yield on sovereign bonds, Chinese onshore government bonds offer positive yields. That matters in a world where for the first time, in 60% of the global economy — including 97% of advanced economies — central banks have pushed policy interest rates below 1%. In one-fifth of the world, policy rates are negative.

For multi-asset investors, positive real yields are critical in protecting real income returns. Chinese real yields on 10-year government bonds have been consistently higher than those in developed markets during the past five years. Since 2019, this differential has increased significantly. This is partly explained by diverging monetary policy – G3 central banks have pushed their real yields steadily below zero – where we expect they will stay for some years yet. Despite strong GDP growth in China over the last 10 years inflation has remained under control. As a result, China now has inflation rates similar to those in developed economies but significantly higher real bond yields. This makes Chinese bonds a standout opportunity, in my view.

The relatively low correlation of Chinese bonds to almost all other asset classes is another consequence of China’s monetary policy being largely independent from those of other major economies. China’s growth is more dependent on internal dynamics than on other economies. This low correlation also reflects that China remains largely a self-sufficient capital market. Currently, China is one of the largest net creditor nations in the world. Domestic investors are dominant in China, having the largest deposit base in the world, equivalent to around USD 40 trillion and still growing.

Onshore renminbi bonds

Investors should understand that China’s bond market is composed of three different segments of which the largest by far is the market for Chinese bonds listed onshore and priced in renminbi (see Exhibit 1 below for a breakdown by sector of the onshore Chinese bond market). This represents around 90% of China’s bond market (the other segments being Chinese debt issued in offshore renminbi, listed in an offshore clearing centre like Hong Kong, and China’s foreign currency issuance).

Exhibit 1: The onshore bond market is by far the largest segment of China’s bond markets – the graph shows the breakdown (in %) of China’s onshore bond market by sector

(Note that the renminbi is the official currency of China where it acts as a medium of exchange, whereas the yuan (CNY) is the unit of account of the country’s economic and financial system)

Source: Bloomberg, PBoC, CCDC, SHCH, JP Morgan, 2019

Improved accessibility to onshore bonds for global investors

Several recent changes in China have furthered the investability of onshore bonds, which over time will be part of the tools China uses to promote financial stability, while also offering a new investment frontier to global fixed-income investors.

Chinese regulators have made considerable efforts to increase the accessibility of the onshore bond market to foreign investors. Programmes like the Bond Connect scheme and China Interbank Bond Market (CIBM) Direct represent major breakthroughs as they allow foreign investors to trade Chinese bonds more easily and freely. Investors can now proceed via an offshore account and are no longer subject to restrictions such as quotas or lock-up periods.

Up until 2018, the only option for offshore investors to hedge their renminbi exposure was via deliverable or non-deliverable forwards. However, in 2018, China announced that deliverable forwards would be made available to foreign investors as a hedging tool.

Hedging of renminbi exposure is now available to foreign investors accessing the market via both the CIBM direct and Bond Connect schemes. The cost of hedging versus the US dollar has fallen significantly to levels well below the historical average of recent years.

What is the outlook for the renminbi?

We are positive on the outlook for emerging market currencies generally in 2021 and on the renminbi in particular. We anticipate strong capital flows back into emerging markets as risk appetite rises once vaccines to COVID-19 become available. China, we think, will lead the way in 2021as the fundamentals for the Chinese currency are positive: the balance of payments is healthy, exports are growing strongly and import growth is relatively contained.

We have already seen significant inflows into Chinese equity markets, but flows into the onshore Chinese bond market have been three to five times stronger than equity inflows.

China is keen to promote greater cross-border use of the renminbi and Beijing is doing its utmost to attract foreign investors to develop China’s financial markets. The ultimate goal is to improve the allocation of capital and develop long-term pension and insurance products.

We see considerable scope for the renminbi to appreciate, but it will not be without volatility. Indeed, the Chinese authorities see some volatility as part of the process of exposing the currency more to market forces. They are seeking a more market-based exchange rate.

Exhibit 2: The Chinese yuan has appreciated significantly in 2020 – graph shows changes in exchange rate of the yuan to US dollar between 02/01/2020 and 09/11/2020. Note that the renminbi is the official currency of China where it acts as a medium of exchange, whereas the yuan is the unit of account of the country’s economic and financial system).

Source: BNP Paribas Asset Management/Bloomberg as of 15/11/2020.

Inclusion of China in global government bond indices – A game changer?

The inclusion of Chinese government bonds (CGBs) in global bond indices is the elephant in the room for global bond investors. I have been covering this market for over 20 years but things are moving even faster than I expected. It is very exciting. Foreign flows into China’s government bond market have been supported by the following news:

– The 20-month phased inclusion of Chinese government and policy bank bonds in the Bloomberg Barclays Global Aggregate Index, which began in April 2019.

– JP Morgan’s decision, in February this year, to start adding Chinese government bonds in its Government Bond Index Emerging Markets (GBI-EM) series over 10 months.

– The announcement last month by FTSE Russell that Chinese Government Bonds will be included in the FTSE World Government Bond Index (WGBI) starting in October 2021 (this date is subject to final affirmation in March 2021).

Index inclusion recognises the efforts made by the Chinese authorities to simplify market access and regulation, and to resolve trading issues, among other things. In the process of opening up Chinese capital markets, this will be another milestone. I expect USD 200-300 billion in inflows into Chinese government bonds just related to the index inclusion.

Index inclusion should boost foreign ownership of Chinese government bonds. It has already risen from 2%-3% to around 8% now. In the medium term I believe it could easily rise to 20%-25%. I think this is a conservative estimate because if foreign ownership rises to the level that we see in South Korea – around 15% – it would imply inflows into the Chinese government bond market of up to USD 1 trillion. That is why index inclusion is potentially a game changer for one of the most under-owned sovereign bond markets in the world.

*According to the same report foreign investors held around 8% of Chinese government bonds

Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. The views expressed in this podcast do not in any way constitute investment advice.

The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

Writen by Jean-Charles Sambor. The post Chinese fixed income – The new frontier for global bond investors appeared first on Investors' Corner - The official blog of BNP Paribas Asset Management.

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International

GBP/USD extends losses on mixed UK data

UK retail sales improve, PMIs remain in contraction The British pound is in negative territory after two days of losses. In the European session, GBP/USD…

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September 22, 2023

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  • UK retail sales improve, PMIs remain in contraction

The British pound is in negative territory after two days of losses. In the European session, GBP/USD is trading at 1.2245, down 0.40%. The struggling pound is down 1.1% this week and is trading at its lowest levels since late March.

UK retail sales improve, PMIs mixed

It is a busy day on the data calendar for UK releases. Retail sales rose in August by 0.4% m/m, following a 1.1% decline in July and was just shy of the market consensus of 0.5%. The sharp decline in July was largely due to unusually wet weather. On an annual basis, retail sales fell by 1.4%, compared to -3.1% in July. Consumer spending has been in a nasty rut, as annualized retail sales have now declined for 17 straight months. The silver lining was that the -1.4% drop marked the slowest pace of contraction in the current streak.

The September PMIs were a mixed bag. The Services PMI slowed to 47.2 in September, down from 49.5 in August and missing the consensus estimate of 49.2. This marked a second straight deceleration and the sharpest contraction since January 2021. The Manufacturing PMI increased to 44.2 in September, up from 43.0 in August and above the consensus estimate of 43.0.

The decline in activity in both services and manufacturing points to a UK economy that continues to cool. The Bank of England, which held interest rates on Thursday, will be hoping that the slowdown translates into lower inflation and that it can continue to hold interest rates.

UK consumer confidence remains low, but there was a bit of an improvement in September. The GfK consumer confidence index rose to -21, up from -25 in August and beating the consensus estimate of -27. This was the highest reading since January 2022, but the economy has a long way to go before consumers show optimism about the economic outlook.

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GBP/USD Technical

  • GBP/USD is testing support at 1.2267. The next support level is 1.2156
  • There is resistance at 1.2325 and 1.2436

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International

“Go To Hell”: Brave EU Politician Delivers Damning Message To Global Tyrants

"Go To Hell": Brave EU Politician Delivers Damning Message To Global Tyrants

Via The Vigilant Fox,

Member of the European Parliament Christine…

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52 mins ago

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September 22, 2023

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"Go To Hell": Brave EU Politician Delivers Damning Message To Global Tyrants

Via The Vigilant Fox,

Member of the European Parliament Christine Anderson has been an unyielding opponent to Klaus Schwab’s ‘Great Reset’ Agenda. Known best for her famous smackdown on Justin Trudeau, MEP Anderson has established herself as one of the few politicians left who represent the interests of the European people.

September 13 was no different as MEP Anderson took no prisoners in her latest warning to the globalitarian elite. Before the European Parliament, in a session specifically focused on the COVID-19 response and the World Health Organization, MEP Anderson ended the meeting with a powerful statement.

Here’s what she said, word for word:

“We just need to find a way to wake the people up. Because the point is simply this: it comes down to a choice. It’s either freedom, democracy, and the rule of law — or enslavement.

“There is no such thing in between. There is no such thing as a little freedom, a little democracy, a little rule of law, just as there is no such thing as a little enslavement. So that’s the choice. It comes down to – it’s either the globalitarian misanthropists or the people. It comes down to – it’s either us or them. And that’s, I think, what this really is all about.

“Now, when my colleagues and I were elected to this parliament, there was no question about it. We were on the side of the people because the people actually pay us to act in their best interests. That’s our job. And once again, I will say to every single elected representative around the world, to every single member in every elected government around the world, if you do not unequivocally stand with the people and serve in their best interests, act in their best interests, you have no place in any parliament or in any government. You belong behind bars. You may even rot in hell for all I care at this point because that’s exactly what you deserve if you sell out the people.”

*Applause ensued*

MEP Anderson continued. “Now, I would like to make a promise to the people, and I’m pretty sure I can speak or speak on behalf of my colleagues. We will continue to stand with you, the people. We will continue to fight for freedom, democracy, and the rule of law. We will not shut up, and we will not stop going after those despicable globalitarian misanthropists.

“But we would also like to have you make a promise to us. You may have heard it’s all coming back. The first country is already starting [to talk about] mask mandates in Israel. They’re already imposing it. I’ve heard of a few universities in the United States. They’re already bringing it all back. And I would really like for you, the people, to not go along. Simply say no! They want you to wear a mask; say no. They want you to put in another mRNA shot; say no. They want to impose a curfew on you; say no. That’s really all you have to do.

“And it might not be or might sound a little hard, but it’s actually not that hard. Because once you have made it clear to them that you will no longer go along, once you’ve let them know, they cannot scare you anymore. Because as long as you are afraid of what they might do if you don’t comply, they have power over you. Take the power away from them! Simply say no. Once you do that, they don’t have power over you anymore. You will feel so free. Simply say no.

“And considering what we’ve heard today, and considering what we’ve seen in the last three years. Considering what we know they want to implement, heck, you might even be well within your right to tell them to screw themselves and go to hell! That’s where they belong. What will you get out of that? I can tell you. Once you’ve done that, once you’ve told them to just go to hell, they no longer have power over you. You will have an incredible feeling — kind of like a sensation of freedom will swap through your body. I promise you will feel so relieved.

“And this is the state of mind that I would ask all of you to get to. Simply don’t let them grind you down anymore. You are worth it. You are deserving of just standing up for yourselves. And tell them all to go to hell. Thank you very much.”

*  *  *

Subscribe to Vigilant News here to receive updates on the latest and most newsworthy stories.

Tyler Durden Fri, 09/22/2023 - 06:30

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Government

Yen Drops After BOJ Does Nothing and Says Little

Overview:  The BOJ’s failure to do anything or
further ideas that an exit of the negative target rate, despite the firm CPI
report helped the dollar…

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September 22, 2023

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Overview:  The BOJ's failure to do anything or further ideas that an exit of the negative target rate, despite the firm CPI report helped the dollar recover the ground lost yesterday against the yen. The focus has returned to "intervention watch" and the market continues to press for the official pain threshold. Sterling is the weakest of the G10 currencies, off another 0.5% today following the BOE's decision not to hike yesterday. The dollar-bloc currencies enjoy a firmer tone. Emerging market currencies are mostly firmer, including the Chinese yuan.

Reports that Beijing is considering reducing some capital controls helped lift Chinese and Hong Kong equities today. Taiwan and Australian equities also advanced, while the other large bourses headed south. Europe's Stoxx 600 is extending yesterday's 1.3% drop, while US index futures are slightly higher. Yesterday's 1.6% drop in the S&P was the largest drop in six months and it was unable to recover from the gap lower opening. That gap (~4375-4401) has technical significance. European bond yields are narrowly mixed, but UK Gilts continue to rally. The US 10-year Treasury yield is slightly softer near 4.48%. Gold has come back firmer after falling more than 0.5% yesterday (its largest loss in around three weeks) and is near the 200-day moving average ($1925). November WTI has steadied and looks to snap a three-day decline. It is back above $90 a barrel and looks poised to settled higher for the fourth consecutive week. 

Asia Pacific

The Bank of Japan did not change its stance, and Governor Ueda gave little hint that a change in rates is possible before the end of the year, as he did earlier this month. Indeed, he suggested those remarks were intended simply to keep the BOJ options open. The dollar, which had fallen to around JPY147.30 yesterday recovered to back toward the recent highs near JPY148.40. Japanese officials underscored they are prepared to counter excessive fx moves. 

Before the BOJ's meeting concluded, Japan reported August CPI figures, which were largely anticipated by the Tokyo CPI previously reported came in a little firmer. The headline rate slipped to 3.2% from 3.3%. The core rates were unchanged. Excluding fresh food, Japan's CPI remained at 3.1% and the measure excluding both fresh food and energy stayed at the cyclical high of 4.3%. Separately, the flash PMI came in softer. The manufacturing PMI eased to 48.6 from 49.6 and the services PMI stands at 53.3, down from 54.3. This saw the composite fall to 51.8 from 52.6. Lastly after buying the most foreign bonds since 2020 in the week ending September 8 (~JPY3.6 trillion or ~$24.5 bln), Japanese investors bought another JPY885.5 bln. Meanwhile, while foreign investors bought JPY438 bln of Japanese bonds, they dumped JPY1.58 trillion of Japanese stocks, most in four years.

Australia's flash PMI showed the service sector grew (50.5 vs. 47.8), while the manufacturing sector slump deepened (48.2 vs. 49.6). Manufacturing new orders were the weakest since May 2020. The composite rose above 50 (to 50.2 from 48.0) for the first time in three months. The central bank meets on October 3 and the market sees practically no chance of a change in rates. 

Yesterday, the dollar traded on both sides of Wednesday's range but the close was within the range, which removed much of the technical significance of the outside day. The broad range may be best explained by short covering of the yen ahead of the BOJ meeting. The dollar is trading back above JPY148.00 as the market continues to test the official resolve. The dollar settled near JPY147.85 last week and has only falling in one week since the end of July. The Australian dollar peaked before the FOMC meeting outcome near $0.6510 and found some bids near $0.6385 yesterday. It settled at $0.6415. It is trading with a firmer bias today and is knocking around $0.6440. To help stabilize the technical tone, the Aussie needs to get back above the $0.6465 area. However, the intraday momentum indicators are stretched in the European morning, suggesting some back and filling in early North American activity. Reports suggesting China is considering lifting some capital controls helped the yuan steady today. The greenback has been in about a 35-pip range on either side of CNY7.30. The dollar's reference rate was set at CNY7.1729. The average in Bloomberg's survey was CNY7.3028 and the gap with the fix was the widest yet. Offshore liquidity is being squeezed.

Europe

Following the flurry of European central bank meetings yesterday, the preliminary September PMI lost some of its luster. Norway, where we thought there was scope for surprise, turned out to be the least surprising. Sweden hiked but was more cagey about another hike, lifting its policy path by 10 bp. Milquetoast. It announced it would liquidate a quarter of its currency reserves, which was unexpected. The Swiss National Bank stood pat, surprising economists. But the swaps market did not think a hike was the most likely scenario, but the franc sold off hard anyway. The market went into the BOE meeting with an almost 50/50 outlook after the soft August CPI. In a 5-4 vote, where Governor Bailey cast the deciding vote, the BOE stood pat. It cut Q3 GDP forecast to 0.1% from 0.4%. However, it increased the pace of the balance sheet unwind to GBP100 bln in the fiscal year beginning next month from GBP80 bln this fiscal year.

The eurozone flash September PMI was mixed. The manufacturing PMI slipped to 43.4 from 43.5 and the services PMI edged up to 48.4 from 47.9. The composite stands at 47.1, up from 46.7. New orders softened to 44.5 from 44.6, which is the lowest since November 2020. Germany's preliminary readings were poor but better than August. The manufacturing PMI is at 39.8 (from 39.1). The services PMI is at 49.8 (47.3). The composite rose to 46.2 from 44.6, the first uptick since April. France moved in the opposite direction. Its PMI fell. The manufacturing tumbled to 43.6 from 46.0. The services PMI is at 43.6, down from 46.0. The composite now stands at 43.5 compared with 46.0 in August, a new low since late 2020. 

The UK reported August retail sales. After falling a revised 1.1% in July (initially -1.2%), UK retail sales rose 0.4% in August, slightly less than the median projection in Bloomberg's survey. The flash PMI was disappointing. While the contraction in manufacturing eased (44.2 from 43.0), the contraction in services deepened (47.2 from 49.5). The composite PMI fell to 46.8 from 48.6, a new three-year low.

After posting an outside down day on Wednesday, the euro extended its decline to almost $1.0615 yesterday, a six-month low, and retested it today. Since the low was recorded, the euro's high has been about $1.0650. The price action, however, is uninspiring and an important low does not seem in place. Sterling was punished for the BOE's failure to deliver a hike, which was roughly 50% discounted. Yesterday's six-month low was near $1.2240 has been taken out today, and a marginal new low closer to $1.2230 has been recorded. Like the euro and yen, sterling recovered into the close of the European session to trade a little above $1.2300. It spent the North American afternoon in about a 10-tick range and settled a couple of hundredths of a cent below $1.23, and today, was sold when it briefly poked above it. Nearby support is seen near $1.22, but the next important target is the $1.2000-$1.2075 area. 

America

US data was mixed yesterday. The Q2 current account deficit was slightly smaller than expected but it was inconsequential. Weekly jobless claims were lower than expected and the four-week average (217k) is the lowest since February. Continuing claims fell to their lowest since January. The September Philadelphia Fed survey was showed a sharp deterioration (to -13.5 from 12.0) and existing home sales fell for the third consecutive month, defying expectations for a small gain, after falling nearly 5.5% in the previous two months. The August index of Leading Economic Indicators continued it uninterrupted decline that goes back to Q1 22. Attention today turns to the preliminary September PMI, where economists expect slightly firmer readings. Still, the market is trying to adjust to the signal by the FOMC sees an economy growing faster than its non-inflationary speed limit, requiring policy to be restrictive for longer. The Fed funds futures strip does not have the first fully discounted in late Q3 24. By comparison, the swaps market has the first ECB cut fully discounted by early Q3. 

Canada reports July retail sales today. Somewhat better numbers than June are expected when retail sales rose 0.1%, driven by autos. With them, retail sales fell by 0.8%. The swaps market has almost an 80% chance of another Bank of Canada rate hike by the end of the year. No cut its priced through Q3 24. Inflation for the first half of September will be reported by Mexico today. The bi-weekly reading may accelerate slightly, but the downtrend in the year-over-year rate should continue. The central bank meets next week, but policy is expected to be steady well into next year. The swaps market seems to be pushing the first cut into Q2 24.

The US dollar popped up to almost CAD1.3525 yesterday. The week and month's low were set on Tuesday near CAD1.3380. The greenback's momentum stalled, and it settled slightly below CAD1.3485. It is trading with a heavier bias but is holding above yesterday's low near CAD1.3450. Support now is seen around CAD1.3440, but the US dollar looks set to trade higher in North America today. After briefly dipping below MXN17.00 before the outcome of the FOMC meeting, the dollar reached MXN17.25 yesterday. That is a little shy of the (38.2%) retracement of the leg down from the nearly four-month high set on September 7 around MXN17.7080. The next retracement (50%) is slightly above MXN17.35. It is consolidating in the European morning mostly MXN17.16. 


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