China fixed income: One-on-one interview
- Spurred by global monetary easing, led by the US central bank’s dovish pivot in 2019, both equities and bonds marked a year of excellent returns. Risk assets continued to rally at the start of 2020, following the announcement of a China-US phase 1 trade deal and a rebound in activity data in China. In the Year of the Rat (beginning January 25), what can international investors expect from the Chinese bond market? In this interview, Ming Leap, Portfolio Manager, Asian Fixed Income, shares his views on what will define the China fixed income market looking ahead, and highlights key investment opportunities in this asset class.
On the back of a global economic slowdown, a temporarily truce in the trade conflict with the US and sluggish growth in investment and manufacturing, what’s the policy outlook for China in the Year of the Rat?
Ming: We began 2020 with a 50bps cut in the reserve requirement ratio (RRR) effective 6th January. The move injected about RMB800 billion of liquidity into the banking system, addressing the seasonal liquidity needs ahead of the Chinese New Year holidays. The latest RRR cut provides support to the private sector, especially small and private businesses, and signals the government’s commitment to offsetting downside risks to the economy.
Going into the Year of the Rat, while most central banks will be on hold, we believe the pace of easing is likely to continue in China, with the People’s Bank of China playing catch-up with the rest of the world in terms of monetary policy. But rather than widespread and across-the-board easing, measures will be surgical and targeted to key sectors as reforms, transformation of the economy and de-leveraging continues.
On the monetary policy front, targeted liquidity injections and prudent cuts in benchmark rates will ease overall borrowing costs to offset the downside risks to the economy. Reforms will progress in order to improve the transmission mechanism to the private sector and the real economy. Meanwhile, fiscal policy will likely focus on ensuring transmission and effectiveness of various measures into the real economy.
Fig 1: Lowering the cost of money to support growth
Source: PBoC, HSBC Global Asset Management, data as of Jan 2020
Why should investors consider investing in Chinese bonds in the current environment?
Ming: Low yields globally remain a structural issue challenging strategic asset allocation and prompting greater regional diversification, including to China, in our view.
For yield-hungry investors, RMB sovereign bond valuations are very attractive especially when considering the fact that a quarter of global bonds are offering negative yields. Even after hedging the currency back to the US dollar or Euro, RMB bonds offer a substantial yield pick-up. The low correlation with other asset classes makes them appealing from a diversification standpoint.
Looking into 2020, we still see value in sovereign and policy bank notes, valuations of which are more attractive than those of developed markets. With the expectation for accommodative policies ahead, we see a steeper yield curve as an opportunity to extend duration within investment grade.
On the corporate side, China dollar bonds still enjoy the so-called “Asian Premium” as they offer attractive valuations, good liquidity with a shorter duration, when compared with US credit market, USD emerging market or Euro credit.
The currency, RMB, should be supported by inflows into bond and stock markets and a weakening USD trend as global risks recede. The reprieve in China-US trade tensions should also help the currency which has underperformed other Asia peers in 2019.
Fig 2: Chinese gov’t bonds offer attractive yields
Yield on 10-year government bond (%)
Source: Bloomberg as of January 2020
Fig 3: The “Asia Premium” over developed markets peers
Source: Bloomberg, HSBC Global Asset Management, December 2019
What’s the default outlook for Chinese bonds?
Ming: The overall pace of defaults in 2019 was similar to that witnessed in 2018, with 35 new defaults in onshore bonds and 6 defaults in the offshore market.
While investors are keen on monitoring how these credit events will play out, the gradual change in the government’s stance, allowing certain debt heavy, less strategically important state-owned enterprises default could be vital to successful credit selection in 2020.
Fig 4: China onshore bond defaults since 2014
Source: Wind as of January 2020
To achieve high quality, sustainable growth in the longer term, it is paramount for China to reallocate its resources from these less productive SOEs to profitable privately owned enterprises.
On a positive note, the China US dollar property bonds should benefit from a slightly more supportive regulatory framework and a stricter system of offshore quotas limiting new bond supplies to refinancing existing bonds only.
In this complex corporate environment, our onshore-offshore cross-border credit research platform and our unified investment process are essential to navigating a more selective and discriminative market.
Fig 5: China USD IG bonds: Fundamentals remain intact
Source: JP Morgan as of December 2019
As part of China’s long-term plan to open up its domestic capital markets, the pace of structural reforms accelerated and onshore bonds were included in a major global index for the first time last year. What are the key market events investors should pay attention to in 2020?
Ming: In 2019, we saw a significant pick-up in usage of bond connect, harmonisation of the access channels for onshore bonds through the removal of quotas and index inclusion by Bloomberg Barclays.
As a result, international participation in China onshore bonds has picked up momentum, pushing the total amount of foreign holdings to exceed the RMB2 trillion mark for the first time.
Following Bloomberg Barclay’s, JP Morgan will take a similar step to add the onshore bonds into its Government Bond Index Emerging Markets (GBI-EM) from February 2020, which could translate into USD3 billion per month of fresh inflows.
While China is facing both internal and external challenges, the policymakers will continue to carry out structural reforms and deregulate domestic markets in order to attract more international participation.
Fig 6: Foreign holdings of onshore bonds
Source: CFETS, PBoC , HSBC Global Asset Management as of January 2020
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