China’s sovereign bonds tumble

 

As China’s sovereign bonds tumble from No 1 ranking, eyes turn to Russia as possible source of funds exodus

• Analysts are speculating on reasons behind a record sell-off in Chinese government debt in recent weeks, but the true cause may not be known for several months
• Sanctions from the United States and European Union have cut off the Russian central bank’s access to much of its foreign reserves

China’s sovereign bonds have plunged from atop the global performance rankings to the bottom half in recent weeks, undermining their status as an alternative haven just as global markets have become roiled by the war in Ukraine.

The return on yuan debt, excluding currency fluctuations, slipped to 29th among 46 sovereign markets tracked by Bloomberg since Russia invaded Ukraine on February 24, according to data compiled by Bloomberg. The securities had topped the rankings in January when they were touted as a haven due to China’s monetary policy divergence with the US Federal Reserve.

There are growing signs that investors are unwinding bets, with global funds selling a net 35 billion yuan (US$5.5 billion) worth of Chinese government debt last month – a record reduction. Pacific Investment Management cut its call as yield differentials with US Treasuries narrowed, while asset-management firm AllianceBernstein warned that Beijing will drive growth by issuing more debt.

China’s sovereign bonds took a hit in recent weeks, losing their top global ranking.

China’s sovereign bonds have plunged from atop the global performance rankings to the bottom half in recent weeks, undermining their status as an alternative haven just as global markets have become roiled by the war in Ukraine.

“China rates have failed to follow the decline in US Treasuries amid global risk-off trades,” Becky Liu, head of China macro strategy at Standard Chartered Bank, wrote in a note. China’s stronger-than-expected gross domestic product (GDP) target for this year “suggests that credit policies may turn more proactive in the near term”, she said, adding that the 10-year yield may rise to 2.95 per cent by the third quarter of this year.

The benchmark 10-year yield has risen 15 basis points from a 20-month low hit in January, to 2.83 per cent, while Treasuries of the same tenor hover near the lowest point since early 2022. China on Saturday announced an economic growth target of about 5.5 per cent for 2022 – at the higher end of many economists’ estimates – while also outlining higher fiscal spending to stimulate the economy.

At the same time, there is a growing chorus of investors who see less room for monetary policy loosening by the central bank after it had cut a key lending rate and boosted liquidity. Traders had bid up Chinese bonds from October as China had pivoted toward easing. China’s central bank said on Tuesday that it will hand over more than 1 trillion yuan (US$158 billion) in profits to the finance ministry – a move that will help the government boost fiscal spending.

“We see more risks than opportunities for reward” in bonds, China Asset Management wrote in a note. The fund said it sees no rate cuts, nor further reserve requirement ratio reductions, from the People’s Bank of China in the near term and expects that the 10-year yield will rise to as high as 3 per cent on growing credit supply.

The sell-off by foreign investors last month was the first since March 2021, according to data compiled by Bloomberg. Domestic funds, brokerages and commercial banks also reduced their holdings of Chinese debt during this period, the data show.

“We believe the sell-off could be driven by tactical asset-allocation decisions on the back of global risk-off sentiment,” said Freddy Wong, head of Asia-Pacific fixed income at Invesco.

“As the Russia-Ukraine conflict worsened, investors rushed into traditional safe-haven assets,” he said, adding that he does not see Chinese bonds as a replacement for traditional havens, yet as they are susceptible to outflows on unexpected events.

There was also speculation that some of the selling may have come from Russia, as sanctions from the US and European Union cut off the Russian central bank’s access to much of its foreign reserves.

“We won’t really know for sure” if Russia’s central bank caused the sell-off in China bonds until toward the end of the year, as it releases its currency composition after a long delay,” said Khoon Goh, head of Asia research at Australia & New Zealand Banking. However, Russia’s aggregate currency-reserves data for end-February could provide some clues, he said.

Goldman Sachs lowered its assessment on Chinese government bonds on Monday on expectations that they may come under pressure if funds have to make up for their inability to access Russian investments by selling other emerging-market assets. Developing-market investors added a net US$1.7 million worth of China bonds last week, compared with US$16.2 million in Indonesian bonds and US$13.7 million in Philippine debt, according to exchange-traded-funds flow data compiled by Bloomberg.

However, some investors continue to see diversification value in Chinese debt. Global investors are currently under-invested in China bonds, said Jason Pang, portfolio manager of JP Morgan China Bond Opportunities Fund. The asset offers “diversification benefits due to its low correlation with global markets and appealing yield opportunities compared with developed-market bonds”, he said.