Asia Pacific Head of Fixed Income, Head of SSGA Singapore
Russia’s surprise invasion of Ukraine sent shockwaves through global markets, dampening risk sentiment and spurring a selloff in equities. And in the fixed-income markets, there appeared to be one unexpected casualty – China’s sovereign bonds.
Data shows that foreign investors slashed their holdings of Chinese government debt by RMB35 billion (about US$5.5 billion) in February 2022. This was the most significant reduction on record and the first decline since March 20211. As a result, the 10-year yield rose from 2.72% to 2.81% over the month2. The speed and scale of this pullback came as a surprise, and its actual cause has yet to be established.
Some market participants speculate that Russia’s central bank has been selling its Chinese sovereign bond holdings to generate cash. Others point toward the tightening monetary environment and rising US yields as the main culprit, noting that they now offer a much-reduced yield pickup3. Falling risk appetite in the wake of the invasion has also been fronted as another possible cause.
The real reason is likely to be a combination of all the above factors. However, as the selling pressure on Chinese sovereign bonds persists, the question is this: should investors join the herd and reduce their allocations to the asset class?
Our thoughts on this question can be summed up by a famous quote from Warren Buffett: “Be fearful when others are greedy, and greedy when others are fearful”4. Rather than trim allocations in the face of pressure, we believe there are strong arguments to invest in this asset class even as others flee.
China’s Easing Cycle Has Just Begun
Back in October 2021, the People’s Bank of China (PBOC) injected almost RMB1 trillion into the banking system in a matter of weeks5. Coming on the heels of a reserve ratio cut a few months earlier (July)6, this was taken as a clear sign that the bank was committed to a path of monetary easing. Accordingly, yields on Chinese sovereign debt started falling, and prices rose.
This supportive pattern persisted until late January 2022, whereby it reversed course. Since then, yields have been trending upwards (to 10 March 2022)7. This led to speculation that the rally in Chinese sovereign bonds was well and truly over8.
Some also argue that China’s easing cycle is likely to have just begun, creating a high likelihood that yields will fall – but this could only be a temporary reversal.
Consider that recent data shows cooling inflationary pressures in China, leaving space for further policy easing9 10 11. Furthermore, the PBOC’s first major easing move – slashing its mortgage lending, loan prime, and short-and medium-term lending rates – only happened in late January12. Subsequently, the central bank’s governor has gone on record, vowing to remain accommodative with monetary policy13.
Taken in combination, this data suggests more policy easing on the horizon and a good chance that yields will resume their downward trend in the near term. While this would indeed reduce the yield pickup offered by Chinese sovereign bonds, it could be more than compensated for with some prospects of capital appreciation. In general, even if Chinese sovereign bond yield do not decline in a large way, it can still act as safe harbour from capital losses of developed bond markets where yields are rising rapidly.
Lower-Risk Diversification Benefits
Potential capital appreciation aside, there are also the continued diversification benefits from holding Chinese sovereign bonds.
Their correlation with other fixed income markets is generally lower, as domestic factors hold a much greater influence over the market. The mere fact that China is easing while the US Federal Reserve is tightening – forcing many other central banks to raise rates to keep pace – is another testament to its diversification benefits. How many other markets have that capability? Add China’s debt-to-GDP ratio, which remains relatively low compared to developed territories14, to the mix, and you have a recipe for lower-risk diversification.
This is quite a contrast with the other options available in the Chinese corporate bond space, where risk appears to have been increasing. While the high-yield sector had naturally been a big attraction for investors given the low-yield environment, the yields have now reached the point of unsustainability. Average yields have breached 20% in the property sector – spurring refinancing risks even as more real-estate developers delay or default on their bond payments15 16.
Ongoing Technical Support Adds to the Final Case
There is also the ongoing inclusion of Chinese government debt to the FTSE Russell World Government Bond Index, which could result in about US$3.6 billion of inflows each month17. This provides a level of technical support that can help offset the selloff in foreign holdings – even if it is only temporary.
However, that may be a big ‘if’. While news headlines like to tout the February dip in foreign investor holdings as a “record selloff”, the truth is the RMB35 billion reduction was only a 1.4% decline, taking the total from RMB2.52 trillion to RMB2.48 trillion18. From that perspective, it is clear the selloff was much more modest than implied by the headlines.
Time to Buy the Dip?
We are presently confronted with a temporary dip in Chinese sovereign bond prices amid a backdrop of continued monetary easing and growing risks in other Chinese bond sectors. All these point toward a strong likelihood that yields will reverse their upward trend – creating a capital-appreciation opportunity for investors who seize the currently low prices. In short, is it time to buy the dip?
All forms of investments carry risks, including the risk of losing all of the invested amount. Such activities may not be suitable for everyone.
Past performance is not a reliable indicator of future performance.
Diversification does not ensure a profit or guarantee against loss.
International Government bonds and corporate bonds generally have more moderate short-term price fluctuations than stocks, but provide lower potential long-term returns.
The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA’s express written consent.
The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor. All material has been obtained from sources believed to be reliable. There is no representation or warranty as to the accuracy of the information and State Street shall have no liability for decisions based on such information.
Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income as applicable.
Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates raise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.
The example mentioned is for illustrative purposes only.
Investing in foreign domiciled securities may involve risk of capital loss from unfavorable fluctuation in currency values, withholding taxes, from differences in generally accepted accounting principles or from economic or political instability in other nations.
Investments in emerging or developing markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.
The views expressed in this article are the views of Kheng-Siang Ng through the period ended 28 February 2022 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
This article is issued by State Street Global Advisors Singapore Limited and has not been reviewed by the Securities and Futures Commission.
This advertisement or publication has not been reviewed by the Monetary Authority of Singapore.