“Stricter regulations to reduce financial market leverage and accompanying tighter liquidity conditions has resulted in one of the largest selloffs in the onshore Chinese bond market in recent years,” said Angus Hui, Schroders’ Asian fixed income fund manager, at a Hong Kong Investment Funds Association (HKIFA) event this week.
The sell-off includes all types of fixed income from government bonds to credit instruments, he said.
Regulatory tighthening on fixed income is part of the overall effort to excercise more control over China's wealth management products.
For example, regulators have recently demanded more transparent and timely reporting of the assets held under banks' most popular wealth management products. These high-yielding investment products, worth RMB 29.1trn ($4.2trn) in total, have about 44% allocated to bonds, according to state-run Securities Times.
As a result of the new requirements, the ten-year treasury yield in China has spiked to 3.7% from below 3% last December.
The ten-year treasury yield in China has spiked to 3.7% from below 3% last December
The higher yield presents buying opportunities. Hui prefers short-dated government bonds against the backdrop of slower economic growth in the second half, due to a decrease in credit expansion in China.
“[Private sector] deleveraging will still take some time, so we are likely to see more volatility in the credit markets, particularly the lower quality credits. We are still very cautious in this area,” he noted.
Bryan Collins, Fidelity International’s fixed income portfolio manager, said the tighter regulations are healthy for the Chinese bond market.
Collins focuses on government bonds and issuance from tier-one state-owned enterprises, policy banks and commercial banks. “The absolute yield of onshore government bonds with a maturity of five-to-ten years, where the ten-year ones are approaching 3.6-3.7% yield, is very attractive.
“These are the high quality credits, government backed or partly government owned, where you can get the best risk-adjusted returns,” he explained.
Chinese government bonds are not correlated to other sovereigns in large developed markets and tend to have a negative correlation to risky assets, which serves as diversification of other assets, he added.
For high yield bonds, “we need to see better transparency and valuations", he added.
Foreign bond buyers
Foreign holdings of onshore Chinese bonds reached RMB 852.6bn ($124bn), or 2.52% of total outstanding value at the end of last year, up from 2.03% a year ago, according to a research report by Hong Kong Stock Exchange.
Foreign holdings are concentrated in sovereign bonds, and other policy bank and China development bank bonds, the report noted, adding that the proportion of those holding sovereigns is also increasing.
“Due to China’s weak market infrastructure, particularly the lack of creditable rating agencies, foreign institutions tend to hold sovereign and high-rated bonds as part of their foreign exchange reserves,” the report said.
Expectations are that the upcoming launch of Bond Connect will attract more foreign capital into onshore fixed income.
China International Capital Corporation (CICC) offered a different point of view: “Although RMB depreciation expectation has eased considerably since 2017, there are still perceived uncertainties surrounding the value of the currency," the firm said in a research note.
"Furthermore, even after the recent adjustments, bond yields in China may have further room to rise after interest rate liberalisation, especially against the backdrop of the ongoing economic reflation."