China’s $13tn bond market shines as Treasuries turn treacherous

Fund managers say China’s $13tn bond market has become an unlikely sanctuary from the volatility that the coronavirus outbreak has let loose in the US and Europe.

The rush for safe assets this year has seen US government bond prices hit record highs and yields hit record lows. This has increased the extra yield offered to investors on Chinese debt, compared with Treasuries, to almost 2 percentage points — the biggest gap in nearly nine years.

Extreme market volatility in March, stemming from the coronavirus pandemic, has shaken up traditional havens such as US government debt, gold and the Japanese yen. But Chinese government bonds, and debt issued by the country’s key development banks, have remained stable by comparison.

All this has prompted some asset managers to anoint China’s renminbi-denominated bond market — the world’s third-largest — as a new refuge. Offshore investors poured in $10.7bn last month, aided by Chinese bonds’ inclusion in global benchmark indices, and traders said the pick-up in foreign buying had continued during March.

“This is going to be the single largest change in capital markets in anybody’s lifetime,” said Hayden Briscoe, Asia-Pacific head of fixed income at UBS Asset Management. 

China’s Bond Connect programme — which allows foreign fund managers to trade in the country’s debt markets without an onshore trading entity — is central to this shift. It has accounted for inflows of more than Rmb500bn ($70bn) since Bloomberg first included government and policy banknotes in its Bloomberg Barclays Global Aggregate index last April.

Foreign demand has helped drive the 10-year Chinese government bond yield lower, but the more dramatic rally in US Treasuries this year has increased the gap between them. That prompted investors like Jason Pang, a fixed asset portfolio manager at JPMorgan Asset Management, to increase their exposure to Chinese debt in recent months.

Mr Pang said the extra yield and lack of correlation with US Treasuries made Chinese debt “particularly attractive in this environment where the virus continues to spread.”

Mr Briscoe at UBS said that activity was stirring in the onshore market, where China’s five largest banks often buy up central government bonds from issuance and hold them until maturity. As international asset managers establish a greater presence, he said, the market for secondary trading in bonds would mature — though the foreign entrants would come as a “shock” to Chinese banks, he added.

However, one longstanding concern among international investors — many of which report trading profits and losses in hard currencies like the dollar — is the potential for moves in the renminbi to eat into trading gains.

“The risk . . . is the currency depreciates faster than the pick-up you’re going to get on the Chinese bonds versus US Treasuries,” said Deepak Mahajan, head of institutional fixed income sales in Asia at Citi.

China’s currency was until recently a global flash point in the trade war, with US president Donald Trump repeatedly accusing Beijing of keeping its currency artificially weak. But the renminbi has been resilient during the coronavirus crisis. It has dropped just 1.4 per cent against the dollar so far this year, while the euro has fallen 3 per cent.

The renminbi has been “incredibly stable”, said Mr Pang, at JPMorgan. Beijing also pledged in US-China trade negotiations not to competitively weaken the renminbi, which “provides investors some comfort that there shouldn’t be any sharp devaluation”, he added.

But China’s bond market will not be plain sailing for foreign investors, traders say, as it has a number of peculiar features. One director at a Shanghai-based brokerage noted that state-run Chinese banks “don’t buy [sovereign and policy bank] bonds because they’re scared; they buy those bonds because they are supposed to”. Banks often bid in order to support Beijing’s economic and policy goals, rather than for profits, he added.

Onshore trading also lacks market-makers to facilitate buying and selling, with bonds trading directly between parties in the interbank market. The brokerage director predicts foreign investors are unlikely to make up more than 5-10 per cent of the onshore bond market. That could help preserve the lower volatility that is currently luring some foreign investors, but means less liquidity compared to US Treasuries, for those wanting to enter and exit the market quickly.

“Policy bonds are a long-term investment here,” said the broker. “It’s not something you should think of as a cash equivalent.”