Foreign investors step up purchases of Chinese government bonds
Deflationary pressures in Asia's No. 1 economy stoke hunger for sovereign debt
HONG KONG -- Foreign investors have added to their holdings in China's domestic bond market for a fifth month in a row, seeking to profit from deflationary pressures in Asia's largest economy.
Net purchases of yuan-denominated government bonds by foreign investors hit 203 billion yuan ($28.2 billion) in January, according to official data published on Monday. It was the fourth-highest monthly inflow since the July 2017 opening of Bond Connect, which enables offshore investors to buy onshore China bonds. The third-biggest inflow came in November.
Using derivatives to hedge their currency risks, foreign investors are hoping to benefit from deflationary pressures and a resulting fall in interest rates in China, according to a note published on Jan. 26 by two OCBC economists, Tommy Xie and Cindy Keung. Bond prices rise when yields fall.
"Given the trajectory of the economy, we have been arguing that now structurally China is in a different growth stage that requires a lower cost of funding overall," Jenny Zeng, chief investment officer of Asia-Pacific fixed income at Allianz Global Investors, said in an interview. She added that she expected the yuan to trade in a narrow range against the U.S. dollar, keeping hedging costs stable.
The growing foreign interest comes despite ratings agency Moody's Investors Service's decision to lower its outlook on China's sovereign bonds to "negative" in December.
Yields on short-term Chinese government bonds climbed following increased bond issuance by the central government in July and August as it sought to stimulate the economy. Strong foreign inflows followed in late 2023, helping to push down yields.
Yields were about 2.38% for China's 10-year government bonds and 1.767% for one-year bonds, according to data on Feb. 26 from China Central Depository & Clearing.
Ju Wang, head of greater China foreign exchange and rates strategy at BNP Paribas, expressed caution about the bond rally. BNP has switched to a neutral position in the market, waiting to see if the government will increase bond issuance after the annual gathering in early March of the National People's Congress and the Chinese People's Political Consultative Conference.
Raymond Chan, chief information officer for Asia-Pacific equity at Allianz Global Investors, said during an investment outlook conference on Monday that the deflationary pressures pushing down bond yields would have a negative effect on the equity market.
The 10-year-bond yield dropping below 2.4% is a "very important indicator," he said. "So long as the deflation cycle is still there, I think it's going to be a concern for the Chinese equity market."
Last year, Chinese government bonds produced a total return in dollar terms of 2%, according to the German asset manager's research, compared with 7% in offshore corporate bonds, negative 20% in offshore high-yield bonds and negative 14% in offshore equities.