The coronavirus crisis has changed many aspects of the world, but chronically low yields across western bond markets is not one of them.
The debt of some of Europe’s biggest economies still trades at negative yields and the US 10-year Treasury — the linchpin of a global bond portfolio — is priced at a rate of just 0.68 per cent.
In Asia’s biggest bond market, however, it is a different story — even if there are not many international investors involved.
Yields on Chinese 10-year government debt have risen steadily from April onwards to trade at more than 3 per cent. And while foreign investors have traditionally owned a tiny fraction of the market, there are signs of change afoot.
“More and more people are coming in, and it’s only the beginning,” says Jan Dehn, head of research at Ashmore Group. “Asia’s going to become very large,” he adds. “Asia markets are going to make their way into all the major global bond indices.”
The international fixed income market is dominated by borrowers and policy in Europe and the US, where expansionary monetary measures have forced interest rates to record lows since the global financial crisis of 2008.
Mr Dehn estimates that more than four-fifths of the roughly $30tn of outstanding emerging market debt is in local currency debt. Emerging market bonds make up a quarter of all fixed income globally as of the end of 2019 but, he said, were underrepresented in the portfolios of bond investors and the indices they track.
Nowhere is the underrepresentation clearer than in China’s domestic bond market, which on its own makes up more than half of all emerging market fixed income by size, but a small proportion of global portfolios. Within emerging market funds themselves, China is also underrepresented relative to its size due to limits on allocations for a single country.
As of August, foreign investors owned just 2.9 per cent of China’s local currency debt, according to a report from French bank Natixis. That is nonetheless a record high, and compares to just over 1 per cent as recently as 2016. Some expect that proportion to climb much higher.
Chaoping Zhu, Shanghai-based global market strategist at JPMorgan Asset Management, says that long-term investors outside of China such as pension funds and insurance companies had “strong interest in Chinese bonds”. He points to “huge” foreign inflows of RMB 148bn ($21.9bn) into Chinese debt in July this year compared with RMB 53bn in the same period of last year.
Access to China’s onshore bonds has been historically tricky to navigate for those investors, though recent measures, such as the Bond Connect programme, launched in 2017, have allowed investors easier access to renminbi fixed income products via Hong Kong.
For Edmund Goh, Asia fixed income investment director at Aberdeen Standard Investments, low levels of foreign investments in Chinese markets mean that when fixed markets globally are moving in one direction, China is less likely to follow suit.
“When you have a bigger portion for your holdings held by foreigners, they are more affected by global macro sentiment,” he says.
Mr Goh adds that, compared with other markets, China was “insulated” and less directly affected by the waves of easy global monetary policy, which he suggests have pushed yields lower across some other issuers in Asia. “You have a lot of markets that used to produce higher yields,” he says. “For the other markets like [South] Korea, Thailand, yields have dropped significantly.”
China is by no means the highest yielding issuer in Asia.
The 10-year Indian government bond currently yields over 6 per cent, in a market where foreign investment is limited by the government.
One major constraint on investment in Asian local currency markets, including China, is currency risk. The renminbi does not have the international status of the dollar, euro or sterling, and flows of capital in and out of the country are closely controlled by government policy.
That further magnifies investors’ vulnerability to changes in Chinese policymaking.
Tensions between the west and China escalated further this summer following Beijing’s imposition of a draconian national security law on Hong Kong. Yet signs of higher appetite for Chinese debt have persisted as Beijing continues a wave of financial liberalisation.
Many of the biggest US fund managers are incentivised by Chinese government reforms to expand their presence in the country and play a greater role in the management of Chinese savings.
The presence of international managers may help familiarise more investors with onshore bonds. More deeply, Ashmore’s Mr Dehn suggests that China’s “intention to continue to open its market”, could herald a shift in the way money works globally.
“All the money has been in the US, it’s been like a magnet of capital,” he adds. “When that magnet loses its power and the money starts flowing back, it starts to ease finance constraints in other parts of the world.”
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