After a strong year, Chinese government bonds remain an area of interest for investors seeking yields that go some way to offset inflation as well as a haven from the war in Ukraine.
In 2021, Chinese bonds were among the best performing globally, thanks to the comparatively attractive yields. Yields on the Chinese ten-year government bond yields fell 34 basis points across the year, resulting in a 6.6% rise in its bond prices. By contrast, global bonds saw yields jump by 40 basis points.
Chinese sovereign bonds attracted a record 575.6 billion yuan ($91 billion) in inflows last year as investors flocked to China to capitalise on the country’s looser monetary policy.
Central bank divergence
Last year, the Fed began to remove pandemic era stimulus, reining in its bond-buying programme, and signaled a rate hike in Q1 of this year. The moves to tighten monetary policy came as inflation surged to a 40-year high, boosted by supply chain bottlenecks, rising energy prices, and higher wages.
The Fed was not alone; the BoC, RBA, ECB, and BoE all took steps to remove pandemic era stimulus. Yet while major central banks across the globe started to tighten monetary policy, the PBOC was and still is on a different path. Inflation in China has not jumped as it has in other major economies. While producer prices - which tend to get exported overseas - have been rising quickly, consumer price inflation in China was just 0.9% in January. Given the low inflation, the PBOC has cut interest rates to lower borrowing costs and support growth.
As a result, demand for Chinese bonds rose as investors looked to get out of US Treasuries before rates started moving up and into China where rates are headed lower.
As 2022 has kicked off, the trend isn’t changing. The PBoC, in its January meeting, lowered the medium-term lending rate facility, highlighting the dovish mood at the central bank, and may cut medium-term lending rates again in March. In sharp contrast, in his testimony before Congress this week, Federal Reserve Chair Jerome Powell as good as confirmed a 25-basis point rate hike in March.
Bond markets typically underperform during a rate hike cycle. However, the monetary policy easing cycle is seemingly just beginning in China, with more rate cuts expected, which is potentially good news for Chinese bonds.
Data shows that holdings in Chinese government bonds rose in January, and the broad expectation is that holdings will continue to grow. Now there appears to be an additional motive behind the trade.
Safe haven play
As geopolitical tensions in eastern Europe escalated to unprecedented levels and Russia’s military attack on Ukraine began, the global markets have experienced a hefty dose of instability. Riskier assets such as stocks have sold off sharply; in fact, the two leading US indices have fallen into correction territory, down 10% from their recent highs - and the Nasdaq entered a bear market.
Currencies are also coming under pressure. The EUR has tumbled to a 20-month low versus the US Dollar, given its vulnerability to the Russian war. Not only is the war on Europe’s doorstep, but Europe is heavily reliant on Russian oil and gas. While the Russian energy sector hasn’t been sanctioned yet, it could just be a matter of time. Even so, oil and gas prices are soaring higher on fears of supply disruption and, as some companies, self-sanction anyway, steering clear of Russian commodities. Stagflation looks to be a genuine problem for the eurozone, and one investors’ are trying to steer clear of - via the Asian continent!
While the US dollar has risen since the start of Russia’s invasion, it is closely caught up in the chaotic fallout from the Russia-Ukraine conflict and global supply chain bottlenecks, sky-high inflation, and questions over how the geopolitical tussle between the US and Russia will play out. That risk in itself could be a sound reason why investors are looking to China.
The situation is very fluid as the Biden administration applies crippling economic sanctions on Russia, which could provoke an even more extreme response from Moscow.
While currencies across the globe took a hit, the yuan is still hovering around a four-year high against the US dollar.
Investing in China is not without risk - state intervention has badly burned investors in the country’s tech sector over the past year. The Chinese economy has been a little unstable due to rising regulatory pressure and de-leveraging but the authorities have shown great determination to stabilise it since the end of last year. In the December economic planning meeting for 2022, Chinese officials stressed the importance and the need for stability. This has significantly supported both the yuan and Chinese treasuries’ safe-haven appeal.
Investors are willing to bet that China’s stability pledges, combined with both fiscal and monetary easing and subdued inflation, could offer protection from the wild swings and, in some cases, unprecedented volatility that is being seen in other markets.
Chinese authorities will be keen to offer a sense of stability ahead of the twice-decade meeting of the ruling Communist party in autumn when President Xi Jinping is set to secure a third term as leader. If they can achieve it, China offers a possible haven for yield-starved investors.