Asian Bond Watch

Get Ready for China’s Inclusion in Major Bond Indices
4 Mar 2019

A resumption of US-China trade talks and a more dovish US Federal Reserve (US Fed) combine to boost investor confidence. This, in turn, triggered a strong rally in risk assets throughout January and the first half of February, with emerging market equities, debt and currencies posting notable gains. Underscoring the improving sentiment is the imminent inclusion of Chinese domestic bonds in global indices in April 2019. As Chinese bond markets become more accessible for foreign investors, we believe they are likely to be well supported by easing policy measures, as well as stronger inflows.

2019 began on a bright note

Year to date (at time of writing), it was positive for risk-on sentiment. In a statement following its January meeting, the US Fed met market expectations of a less hawkish policy this year, announcing that the Federal Open Market Committee “will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate”.

The resumption of trade talks have also brought hopes of progress towards an agreement, which could potentially end a trade spat between the US and China. China has agreed to expand purchases of US goods, ahead of further planned negotiations between the two countries.

Emerging markets recorded four consecutive weeks of fund inflows in the first month of the year. The JP Morgan EMBI Global Diversified Index increased by 3.3% in January, the best monthly performance since June 2016. Other emerging market assets also benefited from the turn in sentiment since last year, with the MSCI Emerging Market Equity Index gaining 8.7% in January, while the MSCI Emerging Market FX Index rose by 2.6%.

A new year for Chinese bond markets

After a difficult 2018, Chinese markets are on the cusp of the Chinese New Year – ushering in the Year of the Pig, an animal that represents luck, wealth and prosperity. While the country faces headwinds from its deleveraging process and the trade dispute with the US, we see several reasons for investors to consider Chinese government bonds, not least their upcoming inclusion in major global indices.

Bloomberg Barclays has already confirmed that it will feature Chinese treasury and policy bank bonds in its USD54 trillion Global Aggregate Bond Index from April 2019, while JP Morgan is evaluating the admittance of Chinese treasury bonds in its flagship local currency emerging market index.

Since early 2016, China has been on a deliberate policy path to open up its financial markets to foreign institutional investors, as part of a broader strategy to internationalise Chinese renminbi as payment and investment currencies in line with its growing stature in world economy. The reforms introduced as a result have accelerated the case for the acceptance of China into mainstream bond indices.

Since China has the third-largest bond market in the world, its inclusion in major bond indices is likely to have a significant impact. If onshore Chinese bonds are included in all fixed income indices, there is potential for around USD420 billion1 of inflows. In fact, local currency Chinese bonds would be the fourth largest currency component of the Bloomberg Barclays Global Aggregate Bond Index, following the US dollar, the Euro and the Japanese yen. Chinese debt would also represent a significant 6% of the index.2

Investor sentiment towards the country will be further encouraged as rating agency S&P Global was recently given the green light by Chinese authorities to become the first foreign organisation of its kind to gain entry into the Chinese market and rate domestic bonds.

Benefits of Chinese bonds

Chinese fixed income offers a number of appealing factors for global investors. In an environment still dominated by low soverign bond yields, Chinese government bonds present an attractive yield premium of around 2% above those of global treasury bonds despite the yield compression in 2018.

In addition, with a small foreign investor base, the Chinese bond market has a very low correlation with global bond markets, for instance, just 0.2 with US Treasury bonds over the past decade. It provides potential diversification benefits to core portfolio exposures.

  1. Source: State Street Global Advisors estimates using the Barclays Global Aggregate, JP Morgan GBI-EM and FTSE Russell World indices and based on the assumption that active managers will buy stocks in anticipation of index flows.
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