Follow up to our previous articles on the China bond investment opportunity. The China government bond investment proposition sounded very attractive in late 2020 and early 2021. But does it still make sense?
In the previous articles in December 2020 and July 2021 on the China Government Bond market opportunity, I had explained the underlying factors supporting the case for investments into Chinese Government and Policy Bank bonds. As with every investment, timing is critical and there are near term factors that dictate the performance of any asset class, which merit tactical shifts that investors need to make in their investment allocations.
Recap from previous articles –
December 2020: The case for investing into China government bonds
- Huge tailwind from the inclusion of China government bonds into the major indices (Bloomberg, JPM and FTSE Russell)
- Significant yield premium compared to US Treasuries. Almost 2% !
- Low correlation to various other asset classes
- Positive outlook on RMB given the significant economic outperformance of China compared to the rest of the world in 2020
- All the above 4 factors increased attractiveness of China government and policy bonds to international investors
July 2021: Yield still attractive, but RMB appreciation has peaked
- A large amount of foreign investor inflows into the China onshore bond market have already taken place and the pace started to slow down
- RMB has appreciated 10-12% over the past 12 months and sits at a level which probably sits a bit outside the comfort zone of the China administration
- Yield premium versus US treasuries still looks very attractive. Still approx. 1.5% -2%
February 2022 Update: Missing foreign investor flow tailwinds, compressing yield premium, weakening domestic economy
Missing Tailwinds. Flows have been robust, but tapering down
With the inclusion of China government bonds into the 3 indexes, the flows into onshore China bonds have stayed true to the projections. Total foreign owned onshore bonds have increased by RMB3.1 Trillion (approx. US$491 Billion) since July 2017. However, the pace of inflows has slowed. See chart below (Note the charts above and below represents total bond market and not just china government bonds. But CGBs form the majority anyways). The tailwind from these portfolio inflows will likely diminish going forward.
Compressing Yield Premium
The yield premium enjoyed by China government bonds has reduced as well. Since July 2021, the premium has almost halved. The 10 year CGB yield has reduced from approx.. 3.15% in mid 2021 to 2.75% in Feb 2022. Similarly, the 10 year US Treasury yield has increased from approx.. 1.2% in mid 2021 to about 2% in Feb 2022. While falling rates in China, might propel CGB prices in local currency terms, a USD investor might need to evaluate currency risk adjusted returns more carefully.
China economy slowing down exacerbating RMB depreciation risks
China’s economy has continued to slow at the start of 2022 as well. Although it posted a record 8.1% GDP growth rate in 2021, that was mostly off a low base in 2020. Year on year GDP growth rate in 4Q 2021 was a modest 4.0%. Here is a summary table of the latest other key economic indicators.
| Manufacturing PMI | 50.1 | Lower than December 2021 reading |
| Caixin Manufacturing PMI | 49.1 | Lowest since April 2020 |
| Retail Sales | 1.7% y-o-y | Lowest since August 2020 as consumption weakened |
With global consumption likely to weaken in 2022 due to the inflation drag, it also seems unlikely that China exports will lend the same kind of impetus to GDP that it provided in 2021.
What’s the summary then?
- If you are still invested in the CGB and Policy Bank Bonds space (either the SGX listed CSOP ETF or Blackrock Ireland domiciled UCITS CNYB and CGBI), it probably makes sense to still hold. The yield still remains attractive even though you will carry currency risk in the non-hedged share classes
- However, I would not initiate a new long position, given how dynamics have changed in the last 18 months
- Continue to watch institutional investors flows into these 2 main ETFs
- Needless to say, US long rates rising from here is not a slam dunk. The chances of Fed policy error are increasing
Happy Investing!
To know more about the China Bond Market and the size, scope and nuances of this market, take our Fixed Income Analysis course and watch the video at the link below!
Disclaimer and Disclosure: Not meant to be investing advice ! Do your own research! I was long China government as well as corporate bonds when I wrote the previous 2 articles. However, I mostly liquidated my China government bond ETF holdings recently and will wait for a suitable opportunity to buy back in.
