Chinese and Asian markets
In a world gone crazy, portfolio protection is indispensable. Global financial markets are in turmoil because of the Russia-Ukraine war and global stagflation risks. Chinese equities have their own troubles too, from delisting risks to COVID lockdowns. In contrast, onshore RMB Chinese bonds are worthy of its reputation as a defensive asset class and remain insulated from global chaos.
Onshore RMB Chinese bonds continued to perform steadily in year-to-date terms despite some foreign outflows in February. By March 18, the Bloomberg China Aggregate Index edged up 0.7% in the year, while other global major fixed income indices dropped 5.2%-8.2%.
Meanwhile, foreign outflows of US$2.3 billion in February from onshore Chinese government bonds should be taken into the context of foreign inflows of US$10.0 billion in January and a cumulative US$98.3 billion in 2021.
Divergence in policy directions: China easing vs. U.S. tightening
Divergence between China and U.S. macro policy directions is a key factor to underpin the performance of onshore RMB Chinese bonds.
With an ambitious target of growing GDP by “around 5.5%” in 2022, China is anticipated to roll out extra easing policies to ward off macro headwinds. The easing pivot is distinct from aggressive tightening plans in the U.S.
The Federal Reserve has started a new rate hike cycle since March and looks to increase interest rate by 175 basis points in total by the end of the year, followed by another 75-90 basis points in 2023. In contrast, since late 2021, the Chinese government has cut a string of benchmark rates to boost lending and consumption. The magnitude of the rate cuts In China is not yet enough to convince investors that the annual GDP growth target will be achieved. In addition, strict measures to contain the recent wave of Omicron across the nation will be a drag on the economy. Hence, we expect China to cut benchmark rates further, among other easing policies, in the next few months to offset the negative impacts of the Omicron outbreaks. In fact, China has vowed to lower real lending rates in its 2022 Government Work Report. In contradiction to some market analysis, we do not view China’s rate reduction possibility to be undermined after the People’s Bank of China transferred 1 trillion yuan to the Ministry of Finance of China. Instead, the transfer indicates more easing measures in different forms are demanded.
In addition, China’s fiscal deficit target of 2.8% this year is below market expectations. This means that an already robust pipeline of local government bonds would have to be compensated by lower-than-expected Chinese government bond issuance. As such, concerns about over-supply of the Chinese government bonds this year may have been overdone.
Due to a pro-growth macro policy stance and restrained supply of government bonds, we expect the 10-year yield of Chinese government bonds to trend lower this year to a range between 2.5% and 2.8%.
Manageable inflation and attractive real yield gap
Behind the different monetary policy approaches of China and the U.S. is inflation. China’s CPI has been moderate, providing room for rate cuts. To the contrary, U.S. CPI inflation is at a decades-high level. The Russia-Ukraine war and the commodity shock it brings will keep inflation at an elevated level in the U.S.
In light of the persistent high inflation, although the nominal yield gap between U.S. and Chinese interest rates has been narrowing, the real yield gap is still wide, making onshore RMB Chinese bonds attractive for yield seekers.
Healthy trade surplus benefits RMB-backed assets
Another pillar to benefit onshore Chinese bonds is the solid performance of RMB. Expectations for aggressive U.S. rate hikes and geopolitical tensions have boosted the USD so far this year, but the greenback’s gain is not necessarily RMB’s loss. RMB’s performance remained resilient and just lost 0.1% in year-to-date terms.
Strong export growth and healthy trade surplus lend support to RMB’s resilient performance. Since the pandemic, Chinese exports have been growing robustly and beating expectations. We expect the robustness to continue when global supply chain bottlenecks endure.
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